Investments, tenth edition

  Regret Avoidance   

Psychologists have found that individuals who make decisions 

that turn out badly have more regret (blame themselves more) when that decision was 

more unconventional. For example, buying a blue-chip portfolio that turns down is not 

as painful as experiencing the same losses on an unknown start-up firm. Any losses on 

the blue-chip stocks can be more easily attributed to bad luck rather than bad decision 

making and cause less regret. De Bondt and Thaler  

10

   argue that such    regret  avoidance    

is consistent with both the size and book-to-market effect. Higher book-to-market firms 

tend to have depressed stock prices. These firms are “out of favor” and more likely to be 

in a financially precarious position. Similarly, smaller, less well known firms are also less 

conventional investments. Such firms require more “courage” on the part of the inves-

tor, which increases the required rate of return. Mental 

accounting can add to this effect. If investors focus on 

the gains or losses of individual stocks, rather than on 

broad portfolios, they can become more risk averse con-

cerning stocks with recent poor performance, discount 

their cash flows at a higher rate, and thereby create a 

value-stock risk premium.