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Applying regret theory to investment choices: Currency hedging decisions

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  • Michenaud, Sébastien
  • Solnik, Bruno
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    Abstract

    We apply regret theory, an axiomatic behavioral theory, to derive closed-form solutions to optimal currency hedging choices. Investors experience regret of not having chosen the ex post optimal hedging decision. Hence, investors anticipate their future experience of regret and incorporate it in their objective function. We derive a model of financial decision-making with two components of risk: traditional risk (volatility) and regret risk. We find results that are in sharp contrast with traditional expected utility, loss aversion, or disappointment aversion theories. We discuss the empirical implications of our model and its ability to explain observed hedging behavior.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 27 (2008)
    Issue (Month): 5 (September)
    Pages: 677-694

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    Handle: RePEc:eee:jimfin:v:27:y:2008:i:5:p:677-694

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    Web page: http://www.elsevier.com/locate/inca/30443

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    Cited by:
    1. Hirigoyen, Gérard & Labaki, Rania, 2012. "The role of regret in the owner-manager decision-making in the family business: A conceptual approach," Journal of Family Business Strategy, Elsevier, vol. 3(2), pages 118-126.
    2. Broll, Udo & Ergozue, Martin & Welzel, Peter & Wong, Wing-Keung, 2013. "Optimal Output for the Regret-Averse Competitive Firm Under Price Uncertainty," MPRA Paper 51703, University Library of Munich, Germany.
    3. Martín Jorge Egozcue, 2012. "Gains from diversification: a regret theory approach," Economics Bulletin, AccessEcon, vol. 32(1), pages 204-219.

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