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Mean Reversion

What is the Mean Reversion?

Mean reversion is a theory according to which the prices return back to the mean. This mean can be the usual average of the price or any other average like return of an industry or growth in the economy.

Understanding the Mean Reversion

The theory has given way to a number of investing strategies that revolve around the sale and purchase of securities and stocks, where the current performance had a bigger difference, than their historic averages. A change in returns means that the company does not have the same prospects like before, which is the reason why a mean reversion might be in place. The phenomena can occur due to a number of factors like price-earnings ratio and interest rates.

How It Works?

Mean reversion is practiced by different traders, and it won’t be wrong to say that sometimes it acts like a self fulfilling prophecy. As the market changes, it starts to attract a lot of investors that want to go against the crowd. When all the participants are at the contrarian side, the market moves back, and gets it to its old self that is more manageable.

For example, the stocks at Samsung move by at least a dollar up or down every day. If one day the stock increases by $5 and there are no announcements, the mean revisionist will assume that the price of the stock will decrease the next day.

Why Is It Important?

It is a quantitative method of investment and trading that is used by people who are actively involved in the market, some of which are not able to make changes in the market.


Further Reading


Real exchange rates and purchasing power parity: mean-reversion in economic thought
www.tandfonline.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mean reversion in stock prices: Evidence and implicationsMean reversion in stock prices: Evidence and implications
www.sciencedirect.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mean reversion and consumption smoothingMean reversion and consumption smoothing
academic.oup.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mechanical mean reversion of leverage ratiosMechanical mean reversion of leverage ratios
www.sciencedirect.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mean reversion in stock prices? A reappraisal of the empirical evidenceMean reversion in stock prices? A reappraisal of the empirical evidence
academic.oup.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mean reversion in short-horizon expected returnsMean reversion in short-horizon expected returns
academic.oup.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Nonlinear mean‐reversion in real exchange rates: toward a solution to the purchasing power parity puzzlesNonlinear mean‐reversion in real exchange rates: toward a solution to the purchasing power parity puzzles
onlinelibrary.wiley.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Momentum and mean reversion across national equity marketsMomentum and mean reversion across national equity markets
www.sciencedirect.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Quasi mean reversion in an efficient stock market: the characterisation of economic equilibria which support Black-Scholes option pricingQuasi mean reversion in an efficient stock market: the characterisation of economic equilibria which support Black-Scholes option pricing
www.jstor.org [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …

Mean reversion and structural breaks in real exchange rates: South African evidenceMean reversion and structural breaks in real exchange rates: South African evidence
www.tandfonline.com [PDF]
During the past three decades – notably since the breakdown of the Bretton Woods system of fixed exchange rates – an ongoing and lively debate has been conducted among international economists concerning purchasing power parity (PPP) and the stability of real exchange …



Q&A About Mean Reversion


What does Samsung stock move by every day on average?

"Samsung stocks move by at least one dollar up or down every day."

How can mean reversion occur?

Mean reversion can occur due to price-earnings ratio and interest rates.

What does it mean for a company's prospects not to be the same as before?

It means that there has been a change in returns.

Who practices mean reversion?

Different traders practice mean reversion.

If Samsung stock increases by five dollars without any announcements being made about it, how would you assume that its value would decrease tomorrow?

"I would assume that its value would decrease tomorrow."

What is the theory of mean reversion?

Mean reversion is a theory according to which prices return back to the mean.

Is it true that sometimes mean revision acts like a self fulfilling prophecy?

Yes, sometimes it acts like a self fulfilling prophecy.

What is quantitative method of investment and trading?

Quantitative method of investment and trading refers to using mathematical formulas for making decisions about

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