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Applying regret theory to investment choices: Currency hedging decisions

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  • Michenaud, Sébastien
  • Solnik, Bruno

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.

Suggested Citation

  • Michenaud, Sébastien & Solnik, Bruno, 2008. "Applying regret theory to investment choices: Currency hedging decisions," Journal of International Money and Finance, Elsevier, vol. 27(5), pages 677-694, September.
    • Handle: RePEc:eee:jimfin:v:27:y:2008:i:5:p:677-694
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    References listed on IDEAS

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    Cited by:

    1. Wong, Kit Pong, 2015. "A regret theory of capital structure," Finance Research Letters, Elsevier, vol. 12(C), pages 48-57.
    2. repec:ksp:journ5:v:4:y:2017:i:2:p:130-159 is not listed on IDEAS
    3. Judith Avrahami & Yaakov Kareev & Einav Hart, 2014. "Taking the sting out of choice: Diversification of investments," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 9(5), pages 373-386, September.
    4. Martín Egozcue & Xu Guo & Wing-Keung Wong, 2015. "Optimal output for the regret-averse competitive firm under price uncertainty," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 5(2), pages 279-295, December.
    5. repec:kap:jrisku:v:55:y:2017:i:2:d:10.1007_s11166-017-9268-9 is not listed on IDEAS
    6. Gollier, Christian, 2016. "Aversion to risk of regret and preference for positively skewed risks," TSE Working Papers 16-646, Toulouse School of Economics (TSE), revised Sep 2016.
    7. Udo Broll & Peter Welzel & Kit Pong Wong, 2016. "The Impact of Regret on Exports," German Economic Review, Verein für Socialpolitik, vol. 17(2), pages 192-205, May.
    8. Tracey West & Andrew Worthington, 2014. "Macroeconomic Conditions and Australian Financial Risk Attitudes, 2001–2010," Journal of Family and Economic Issues, Springer, vol. 35(2), pages 263-277, June.
    9. 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.
    10. Korn, Olaf & Rieger, Marc Oliver, 2016. "Hedging with regret," CFR Working Papers 16-06, University of Cologne, Centre for Financial Research (CFR).
    11. Qin, Jie, 2015. "A model of regret, investor behavior, and market turbulence," Journal of Economic Theory, Elsevier, vol. 160(C), pages 150-174.
    12. Guo, Xu & Wong, Wing-Keung & Xu, Qunfang & Zhu, Xuehu, 2015. "Production and hedging decisions under regret aversion," Economic Modelling, Elsevier, vol. 51(C), pages 153-158.
    13. repec:eee:jetheo:v:172:y:2017:i:c:p:88-119 is not listed on IDEAS
    14. Martín Jorge Egozcue, 2012. "Gains from diversification: a regret theory approach," Economics Bulletin, AccessEcon, vol. 32(1), pages 204-219.
    15. repec:spr:annopr:v:268:y:2018:i:1:d:10.1007_s10479-017-2475-6 is not listed on IDEAS
    16. Rachel J. Huang & Alexander Muermann & Larry Y. Tzeng, 2016. "Hidden Regret In Insurance Markets," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(1), pages 181-216, January.
    17. repec:ksa:szemle:1783 is not listed on IDEAS
    18. Han Bleichrodt & Peter P. Wakker, 2015. "Regret Theory: A Bold Alternative to the Alternatives," Economic Journal, Royal Economic Society, vol. 0(583), pages 493-532, March.
    19. repec:ksp:journ5:v:4:y:2017:i:3:p:402-403 is not listed on IDEAS
    20. Bruno Solnik & Luo Zuo, 2012. "A Global Equilibrium Asset Pricing Model with Home Preference," Management Science, INFORMS, vol. 58(2), pages 273-292, February.
    21. Gollier, Christian, 2016. "Explaining rank-dependent utility with regret and rejoicing," IDEI Working Papers 863, Institut d'Économie Industrielle (IDEI), Toulouse.

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