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Regret-sensitive equity premium

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  • Fujii, Yoichiro
  • Nakamura, Yutaka

Abstract

In a static Lucas tree economy, we propose a model that the representative agent is sensitive to regret, that is, the agent is affected by not only the actual outcome but also value-differences between actual and foregone consequences. Our model generalizes the classical simple regret model pioneered by Bell (1982) and Loomes and Sugden (1982), and makes it possible to derive the equilibrium asset price and to see when the regret effect decreases the price. To verify that our model predicts sufficient decreases of the equilibrium price to explain the empirically high risk premium, we analyze the data of U.S. stock market and GDP growth rates during 1871–2018. The numerical calculation indicates that the estimated equilibrium price is small enough to explain the equity premium puzzle.

Suggested Citation

  • Fujii, Yoichiro & Nakamura, Yutaka, 2021. "Regret-sensitive equity premium," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 302-307.
    • Handle: RePEc:eee:reveco:v:76:y:2021:i:c:p:302-307
    DOI: 10.1016/j.iref.2021.06.011
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    References listed on IDEAS

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    Cited by:

    1. Yoichiro Fujii & Hajime Murakami & Yutaka Nakamura & Kazuhisa Takemura, 2023. "Multiattribute regret: theory and experimental study," Theory and Decision, Springer, vol. 95(4), pages 623-662, November.
    2. Yang, Ann Shawing, 2023. "Regret sensitivity and stock certificate loss reporting: Evidence from Taiwan," Finance Research Letters, Elsevier, vol. 58(PA).

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    More about this item

    Keywords

    Regret theory; Equity premium; Lucas tree economy; Equilibrium price;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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