Individual decisions under risk, risk sharing and asset prices with regret

We consider an Arrow-Debreu economy in which expected-utility-maximizing agents are sensitive to regret. According to regret theory, the marginal utility of their consumption is increasing in the maximum payoff that they could have obtained if they would have made another choice ex ante. We show that regret biases the optimal portfolio allocation towards assets that perform particularly well in low probability states. The competitive asset pricing kernel is convexified by regret if the distribution of the macroeconomic risk is logconcave. Regret also reduces the equity premium when the macro risk is positively skewed. We characterize the competitive allocation of risk when consumers have heterogenous preferences, and we show how to aggregate individual intensities of regret.

[1]  B. Jullien,et al.  Estimating Preferences under Risk: The Case of Racetrack Bettors , 2000, Journal of Political Economy.

[2]  A. Tversky,et al.  Prospect theory: an analysis of decision under risk — Source link , 2007 .

[3]  Robert B. Wilson.  THE THEORY OF SYNDICATES , 1968 .

[4]  Alexander Muermann,et al.  Regret, Portfolio Choice, and Guarantees in Defined Contribution Schemes , 2006 .

[5]  A. Tversky,et al.  Prospect Theory : An Analysis of Decision under Risk Author ( s ) : , 2007 .

[6]  R. Sugden,et al.  Some implications of a more general form of regret theory , 1987 .

[7]  Prospect Theory and Asset Prices , 1999 .

[8]  Bruno Solnik,et al.  Hedging Currency Risk : a Regret-Theoretic Approach , 2005 .

[9]  David E. Bell,et al.  Risk Premiums for Decision Regret , 1983 .

[10]  R. Mehra,et al.  THE EQUITY PREMIUM A Puzzle , 1985 .

[11]  David E. Bell,et al.  Disappointment in Decision Making Under Uncertainty , 1985, Oper. Res..

[12]  R. Engle,et al.  Empirical Pricing Kernels , 1999 .

[13]  A. Sirigu,et al.  The Involvement of the Orbitofrontal Cortex in the Experience of Regret , 2004, Science.

[14]  Robert Sugden,et al.  An Axiomatic Foundation for Regret Theory , 1993 .

[15]  R. Sugden,et al.  Testing for Regret and Disappointment in Choice under Uncertainty , 1987 .

[16]  J. Elster.  Emotions and Economic Theory , 1998 .

[17]  David E. Bell,et al.  Regret in Decision Making under Uncertainty , 1982, Oper. Res..

[18]  Louis Eeckhoudt,et al.  A Good Sign for Multivariate Risk Taking , 2006, Manag. Sci..

[19]  Alexander Muermann,et al.  The Impact of Regret on the Demand for Insurance , 2004 .

[20]  R. Sugden,et al.  Regret Theory: An alternative theory of rational choice under uncertainty Review of Economic Studies , 1982 .

[21]  John Quiggin,et al.  Regret theory with general choice sets , 1994 .

[22]  George M. Constantinides,et al.  Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation , 1982 .

[23]  G. Loomes.  Further Evidence of the Impact of Regret and Disappointment in Choice under Uncertainty , 1988 .

[24]  Andrew B. Abel,et al.  An Exploration of the Effects of Pessimism and Doubt on Asset Returns , 2000 .