A model of regret, investor behavior, and market turbulence

This study examines the effects of regret on investor behavior and market turbulence by using a model where investors not only regret wrong actions but also regret inaction. We demonstrate that regret aversion can cause investors to ride a bubble, exit and reenter the market, or choose not to trade. Further, herds and partial herds can occur in the market, and we show that the stronger regret over inaction, the easier it is for herds to occur. The model presented herein also predicts that during the formation of a bubble (crash), bearish (bullish) traders tend to exit and reenter the market, thereby causing a positive (negative) correlation between order volume and order imbalance.