Regarding Regret Bias:
A client with a regret bias has two stocks in his portfolio;
Stock A, Purchase price was USD50, and current price is USD60
Stock B, Purchase price was USD 55, and current price USD47
The correct answer is that he would fear to take any action in either stocks. But I have two questions regarding the example;
Does this mean that for a client with regret bias, the portfolio has to be discretionary where the manger takes all the decisions and the client is not involved in the decisions after formulating the IPS.
The second question is why did not the client purchase stock A, in order not to regret any further increases?
To answer your first question, there’s a reading section on portfolio alteration to account for behavioral biases. Since regret bias is an emotional bias, if the client is rich, the PM would make a 10-15% adjustment to the portfolio from the mean-variance efficient portfolio. If the client is poor (and has emotional bias), you’d make a 5-10% adjustment. On the other hand, if the client has cognitive biases, you’d alter the portfolio by 5-10% and under 5% respectively if they are rich or poor. In sum:
Emotional and Poor: 5-10% Emotional and Rich: 10-15% Cognitive and Poor: <5% Cognitive and Rich: 5-10% This is because you can’t “teach away” emotional biases, so you act by making changes to the portfolio from the MVO efficient allocations. On the other hand, you can provide information and training to correct cognitive biases, so the adjustment needed is less. Finally, you can’t afford to make too many deviations for a poor portfolio, which explains lower deviations for poor portfolios regardless of the type of bias. Your second question is too much of a “what if/why not” and doesn’t make sense. Regret bias by definition is an emotional bias where you don’t take action out of fear that you might miss out (have regret).