Regret to reward: Investor regret and the cross-sectional stock returns in the Chinese market

This study investigates the cross-sectional asset pricing implications of investor regret in the Chinese stock market. Using a comprehensive sample spanning January 2000 to November 2021, we find that regret is positively related to the cross-section of future equity returns. A strategy that involves longing a portfolio with the highest regret and shorting a portfolio with the lowest regret generates annualized risk-adjusted returns of 11.64 %. In addition, the regret premium is more pronounced for stocks with high arbitrage limits and information frictions. The regret anomaly persists after considering established asset pricing factors through extensive sensitivity analyses. Overall, our findings remain consistent with our hypothesis that regret-averse investors generally avoid stocks that generate high regret as these stocks have reduced overall utility compared with others. Consequently, these high regret stocks tend to deliver higher future returns in equilibrium. Our results provide valuable insights for policymakers and regulators to better understand how investors' emotional behaviors such as regret can affect stock dynamics, particularly in emerging and retail-driven markets.