Regret aversion in Japanese and U.S. stock markets: Analyzing the effects of market conditions

Somyung Kim and Kiyool Ohk

Japan and the World Economy, 2025, vol. 74, issue C

Abstract: This study examines the effects of investors’ regret aversion and regret premium on investment decision-making and stock returns in the Japanese and U.S. stock markets from a behavioral finance perspective. Using regret variables, we demonstrate that regret aversion significantly impacts asset pricing. Our empirical results show that investors demand a higher regret premium when holding high-regret assets, and this relationship persists even after controlling for various firm characteristics. By analyzing market states and dynamics, we find that regret aversion is particularly strong in down markets, though its influence weakens in up markets. Market dynamics analysis reveals that regret premiums are most pronounced during simultaneous upward market trends. Robustness tests using cumulative returns and industry-adjusted short-term return reversals further confirm the significant influence of regret on stock returns. Additionally, our analysis of irrational investor behavior, including the disposition effect and psychological price barriers, shows that regret aversion is more pronounced in the context of unrealized capital losses and when asset prices deviate significantly from psychological price barriers. This study provides comprehensive insights into the impact of regret aversion and market dynamics on investor behavior and asset pricing, challenging traditional finance theories grounded in the assumption of rational decision-making.

Keywords: Behavioral finance; regret; regret aversion; market states; market dynamics; disposition effect; psychological price barriers (search for similar items in EconPapers)
JEL-codes: G00 G11 G15 G30 G40 G41 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:japwor:v:74:y:2025:i:c:s0922142525000155

DOI: 10.1016/j.japwor.2025.101311

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