Behavioral Finance biases: A Comprehensive Review on regret approach studies in portfolio optimization

Abstract

In the ever-evolving realm of finance, investors have a myriad of strategies at their disposal to effectively and cleverly allocate their wealth in the expansive financial market. Among these strategies, portfolio optimization emerges as a prominent approach used by individuals seeking to mitigate the inherent risks that accompany investments. Portfolio optimization entails the selection of the optimal combination of securities and their proportions to achieve lower risk and higher return. To delve deeper into the decision-making process of investors and assess the impact of psychology on their choices, behavioral finance biases can be introduced into the portfolio optimization model. One such bias is regret, which refers to the feeling of remorse that can induce hesitation in making significant decisions and avoiding actions that may lead to unfavorable investment outcomes. It is not uncommon for investors to hold onto losing investments for extended periods, reluctant to acknowledge mistakes and accept losses due to this behavioral tendency. Interestingly, in their quest to sidestep regret, investors may inadvertently overlook potential opportunities. This research article aims to undertake an in-depth examination of 41 publications from the past two decades, providing a comprehensive review of the models and applications proposed for the regret approach in portfolio optimization. The study categorizes these methods into accurate and approximate models, scrutinizing their respective timeframes and exploring additional constraints that are considered. Utilizing this article will provide investors with insights into the latest research advancements in the realm of regret, familiarize them with influential authors in the field, and offer a glimpse into the future direction of this area of study. The extensive review findings indicate a growth in the adoption of the regret approach in the past few years and its advancements in portfolio optimization.

Keywords

• portfolio selection
• regret biases
• loss aversion
• behavioral finance
• market psychology
• bibliometrics