Author(s) :

Yusuf Efe Kızılöz.

Volume/Issue :

Abstract :

This paper examines how two behavioral biases, the endowment effect and the disposition effect, shape portfolio choices and challenge the assumptions of the Efficient Market Hypothesis (EMH). EMH assumes that asset prices completely incorporate all information available and that investors are rational in their behavior. Yet findings in behavioral finance on these two effects demonstrates systematic deviations from rationality. The disposition effect captures investors’ tendency to sell winning assets too quickly while irrationally holding losing ones; the endowment effect describes individuals’ assigning greater value to assets they already own than to identical assets they do not. These are the principal sources of bias examined in this paper. Far from random, these behaviors repeat themselves systematically across markets, investor groups, and time periods, thereby weakening EMH’s methodological assumption that countervailing irrationalities cancel one another. They reduce diversification, delay portfolio rebalancing, and distort the intended risk–return trade-off, pushing investors away from the efficient frontier. Their persistence also constrains the EMH assumption that arbitrage always corrects mispricings, since real markets face transaction costs and structural frictions that prevent full adjustment. By showing that psychological factors—such as reluctance to realize losses, reference dependence, and ownership-driven attachment—steer investment decisions, this study argues that classical financial models must be extended. In brief, while EMH is a helpful theoretical benchmark, it cannot fully account for market action when psychology-based biases exist. To understand how investors choose, how portfolios evolve, and how markets actually function, behavioral perspectives must be integrated.