The importance of regret was first formally pointed out by Robert Sugden and Graham Loomes in a paper written in 1981, coincidentally the year in which Bullseye first aired. And as Han Bleichrodt and Peter Wakker write in the latest issue of the Economic Journal, the desire to avoid regret has "huge" power to explain economic behaviour.
One trivial example of this is that we buy insurance even if it is overpriced in actuarial terms. We do so to protect ourselves from regret; if our house burns down we would bitterly regret not having insurance. Insurers make money by from this: they can charge a higher than fair price for insurance, thus collecting a regret-avoidance premium.
Avoiding regret also shapes our asset allocation decisions. Alexander Muermann at the University of Pennsylvania says it causes us to "hedge away from the extremes". Standard theory predicts that at some level of expected returns on equities a moderately risk-averse investor would put everything into shares. Regret-aversion, however, predicts that he wouldn't, because he wants to avoid kicking himself in the (ex hypothesi unlikely) event of shares falling.
Conversely, conventional theory says that no risk-averse investor would want shares if the risk premium is zero. Regret theory, however, says he would, because he wants to avoid regretting missing out on gains in the unlikely event that shares do rise. This might help explain why people don't follow the 'sell in May' rule even though it has worked on average: they fear they'd kick themselves on the rare occasions when shares do rise over the summer.
This also helps explain why bubbles happen; some people buy houses (and in 1999, shares) at high prices for fear of regretting missing out on further gains.
In this sense, regret aversion generates conformity. If we follow the crowd we won't regret doing so because if things go wrong we can comfort ourselves with the thought that others lost out too. But if we go it alone and lose, we will regret our pig-headedness. Salesmen, of course, have long known this; one of the most effective marketing slogans of all time was 'nobody ever got fired for buying IBM'.
Herein lies an important fact about regret, which Mr Bowen knew. We only regret our choices if the alternatives are obvious. Few of us, for example, regret not buying Voltari last month even though it has risen 600 per cent in the last month simply because small Nasdaq stocks are not on our radar. But we might regret having missed out on buy-to-let returns because these are more salient and were a feasible choice.
This implies that we might reduce regret by sticking to rules. If you follow the rule 'don't buy Aim stocks' you'll not regret missing out on the occasional stellar gain whereas you will do so if you look for 10-baggers. (You will, though, regret it if Aim outperforms the main market - but history tells us this is a rare event.)
Regret theory doesn't just help explain investors' behaviour, however. It can also explain some political behaviour which you might find annoying. One reason why there are ever-increasing amounts of bureaucracy and red tape is that politicians (and company managers) fear that they'd regret deregulating. Who wants to be the politician who liberalises gun laws before a mass shooting, or health and safety laws before a big industrial accident?
This poses the question: is it rational to feel regret or not? The old proverb 'don't cry over spilt milk' says it isn't. But, on the other hand, it's quite reasonable to take care not to spill the milk in the first place. And regret is such a ubiquitous emotion that it would be futile to implore people not to feel it.
Perhaps, though, the problem isn't so much our desire to avoid regret so much as the way in which we frame our choices. Psychologists and salesmen have long known that our choices are sensitive to how they are framed: 'discount' sounds better than 'penalty' and 'survivor rate' better than 'death rate' even though they are only mirror images of each other. If we frame our investment choices badly - for example, by fearing missing out on short-term gains on expensive assets or worrying about what others are doing - then we are likely to make bad decisions however much we try not to fear regretting it.
