Regret and Asset Pricing

I investigate the consequences of regret aversion for asset prices in an otherwise standard model of financial markets. This paper shows that accounting for investors’ regret aversion can help explain the risk-free rate puzzle, excess volatility, the downward sloping term structure of equity risk premiums, and the predictability of stock returns both in the time series and in the cross section. The model also evaluates bond behavior and predicts a downward sloping real yield curve. I provide an empirical measure of regret which confirms empirically the main model’s testable predictions. This paper is the first to document the linkage between regret aversion and many  stylized facts concerning asset prices.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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