Regret (decision theory)

In decision theory, on making decisions under uncertainty—should information about the best course of action arrive after taking a fixed decision—the human emotional response of regret is often experienced. The theory of regret aversion or anticipated regret proposes that when facing a decision, individuals might anticipate regret and thus incorporate in their choice their desire to eliminate or reduce this possibility. Regret is a negative emotion with a powerful social and reputational component, and is central to how humans learn from experience and to the human psychology of risk aversion. Conscious anticipation of regret creates a feedback loop that elevates regret from the emotional realm—often modeled as mere human behavior—into the realm of the rational choice behavior that is modeled in decision theory.

Regret theory models choice under uncertainty taking into account the effect of anticipated regret. It was originally developed simultaneously by Graham Loomes and Robert Sugden, David E. Bell and Peter C. Fishburn and subsequently improved upon by several other authors.

In general, these models incorporate a regret term to the utility function that depends negatively on the realized outcome and positively on the best alternative outcome given the uncertainty resolution. This regret term is usually an increasing, continuous and non-negative function subtracted to the traditional utility index. These type of preferences always violate transitivity in the traditional sense although most satisfy a weaker version.

Several experiments over both incentivized and hypothetical choices attest to the magnitude of this effect.

Experiments in first price auctions show that by manipulating the feedback the participants expect to receive, significant differences in the average bids are observed. In particular, "Loser's regret" can be induced by revealing the winning bid to all participants in the auction, and thus revealing to the losers whether they would have been able to make a profit and how much could it have been (a participant that has a valuation of $50, bids $30 and finds out the winning bid was $35 will also learn that she could have earned as much as $15 by bidding anything over $35.) This in turn allows for the possibility of regret and if bidders correctly anticipate this, they would tend to bid higher than in the case where no feedback on the winning bid is provided in order to decrease the possibility of regret.

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