Regret-aversion bias

CFA Level III Portfolio Management
#1

Regret-averson bias occurs when market participants do nothing out of excess fear that actions could be wrong.

Question: if herding behavior, momentum trading, belongs to this bias? Thanks.

#2

From CFAI, Book 2, Reading 7, section 4.6.2:

“Regret bias can have two dimensions: actions that people take and actions that people could have taken. More formally, regret from an action taken is called an error of commission, whereas regret from an action not taken is called an error of omission […] Regret is more intense when the unfavorable outcomes are the result of an error of commission versus an error of omission. Thus, no action becomes the preferred decision.”

So, regret aversion may either lead financial market participants not to take action or it may bring them to “invest in a similar fashion and in the same stocks as others. This herding behavior alleviates some of the burden of responsibility. As John Maynard Keynes (1936) writes in Chapter 12, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.””

In so far as momentum is related to herding behavior as described in Reading 8, Section 7.2, it is possible to argue that momentum trading may have something to do with regret but it seems to me that the link between momentum and regret is pretty flimsy and probably unnecessary.

All the best, Carlo

1 Like
#3

Thanks Carlo.

#4

Thanks. This is the only place I hear of material linking regret aversion to herding. This would have helped me get 5-C of 2017 mock right.