Behavioral biases, such as overconfidence, loss aversion, confirmation bias, and anchoring, significantly distort individual decision-making processes. These biases lead to suboptimal portfolio performance, characterized by excessive trading, delayed loss realization, and inefficient information processing. At the market level, these biases aggregate into systemic anomalies like herding, overreaction, and momentum effects. These anomalies undermine market efficiency due to limits to arbitrage and the influence of noise trader sentiment. This paper examines the profound impact of behavioral biases on both investor performance and market efficiency, challenging the traditional financial theories that assume market rationality. Empirical evidence reveals significant negative impacts on investor returns and prolonged mispricing durations. These findings highlight the necessity for a multidisciplinary approach that integrates cognitive psychology and financial economics to better understand and address these pervasive issues in financial markets. By bridging these disciplines, this research aims to provide actionable insights for portfolio management and regulatory design, ultimately enhancing market efficiency and investor outcomes.
Hanwen Zhang (2025) studied this question.