Behavioral finance FAQ / Glossary (Regret)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

Regret aversion / avoidance / minimization. Expected Regret


00/7i - 07/3i,4i + see aversion, loss
aversion, consensus,
underreaction,
delaying tactic, disappointment
aversion + bfdef2

After being scalded when the pot fell,
a cat is afraid even of cold water.

Definition (Regret)

Ouch!

Regret is an emotional reaction, a pain felt when
facing the negative effects  (or the lack of positive
effects) of one's own decision or move (or lack of move).

In economics and finance, a decider might suffer such a guilt 
feeling when
its action (or lack of it) brought a loss or missed a gain.

Regret vs. disappointment

My fault / not my fault ?
Must be your fault ;-)

Regret.

This hand wringing strikes when the player considers the failure as due to its
error of
judgment.


 Disappointment

 A pain similar to regret, but less acute, can also strike when the damage comes
 from the
general uncertainty that any decider faces when taking any decision.

 Here we have "disappointment" (see that word) more than regret.

 In this case, as the decider could not predict those harmfiul consequences,
 it does not consider thy were caused by its move (or lack of move=.

The margin between the two phenomena is thin, as:

There is some tendency to attribute (see rationalization,
   attribution) the failure to other people or to the general environment,

even when it comes from our own neglects or illusions (of knowledge,
competence...).

Whodunit? Who knows, Your Honor!

On the other hand we might feel emotionally guilty for damaging events
   that did really depend of us

Always have in mind that uncertainty is king, nobody can win all the
battles
.
Actually, as probabilities
go, the regression to the mean makes that
series of bad luck and of good luck alternate.
So after an error, the good reaction is just to say "I have learnt
something, so next time I will do better"

Definition (Regret aversion)

The fear to be sorry.

Regret aversion is the fear of experiencing the pain of regret. It is OK if it
makes us wiser.

Except that there is a problem:

A reaction which, instead of addressing an actual damage, is based on an
anticipation and fear of regret
can thwart the decision process.

When investors, under an emotional approach,

try to avoid a situation of regret / disappointment,

they might take an even bigger risk.

They would prefer

* to renounce to make a decision (*),

* or sometimes on the contrary to rush it.

(*) Actually, the regret aversion most often feeds the tendency to choose
    that
"default option", which consists in changing nothing.

This is because the regret is usually lower when a bad result comes
from a "decision not to act" rather than a decision
to do something.

This emotional bias for inaction has some relation with the endowment and
commitment
effects.

It is of course even more directly related to the status quo bias

(see those phrases).

See also the general "aversion" article that shows the relations
between
risk aversion, prospect theory, loss aversion, regret
aversion, disposition effect...

Practical examples in investing

From delaying to chasing

In practice, investors, caught in this regret avoidance strategy, might:

Be prone to delaying tactics and the status quo bias
   (see above).

There is a rather usual but strange asymmetry in favor of inaction /
paralysis instead of action.
It might even be institutionalized (the so called precautionary
principle
which is an initiative killer)

This is because people usually feel more responsible
of the bad result of a move they did than of the
bad result of staying
inactive


Avoid to sell stocks on which they are losing money
   (see loss aversion).

They think of the regret they would experience if their 
prices recover.

But this is taking the risk to lose even more.

A mental asymmetry again!

The paradox is that in some cases, after waiting too long, the
pain gets unbearable.

Then they might throw in the sponge in despair and sell at its
lowest price, when the recovery gets possible (see capitulation).


Try to catch that train even if it is too late when they regret

to have missed an opportunity (for example a stock rise),

They "run after a stock" that they did not spot - or did
not invest in - in the first place but that has now been
over-performing in a big way.

This chase due to regret is another reason why underreaction is often
followed by overreaction (see those words),


Prefer to buy what everybody is hot

about instead of one in which they personally see better
prospects.

By choosing the popular investment, they lower their
regret expectation
whatever will happen.

* If the price of this widely praised asset falls, they would not have 

to attribute their loss  to their own lack of foresight.

They would not feel culprit for the mistake, as they will
attribute it to the  other people or to unforeseeable events.

They would only feel then a "disappointment" (see that word),
nt a regret.

* On the contrary, regret would be strong if things turn bad for an

asset they bought while it was widely shunned by the other
players...

They anticipate more or less consciously that in that case they
would feel responsible of having erred from the consensus.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

 Members of the BF Group, please
 vote on the glossary quality at BF polls

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This page last update: 24/08/15  

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