Considering regret in optimal asset allocation for portfolios
Assets that inspire the most regret tend to be more speculative in nature. Risk levels may rise when regret is taken into account in portfolios
HOW is risk defined in portfolio optimisation? Usually with a volatility metric, and often one that places a particular emphasis on downside risk, or losing money.
But that only describes one aspect of risk. It doesn’t capture the entire distribution of outcomes investors could experience. For example, not owning an asset or investment that subsequently outperforms could trigger an emotional response in an investor – regret, for example – that resembles their reaction to more traditional definitions of risk.
That’s why to understand risk for portfolio optimisation purposes, we need to consider regret.
