Introduction there have been a large number of studies see among others poterba and summers 1, or spierdijk, bikker and. Poterba and summers w2343 mean reversion in stock prices. Mean reversion in stock market prices kyiv school of. Poterba and summers 1988, for example, find positive. As an a priori matter, it is cult to argue for assuming that transitory components should oust rapidly. Poterba and summers 1988 claim, however, that the magnitude of change in interest rates should be very huge to cause mean reversion patterns. The relationship between market sentiment index and stock. Summers harvardandnber december1986 revisedaugust1987. Cutler d poterba j and summers l speculative dynamics and the role of feedback. Transitory market states and the joint occurrence of momentum. For the purpose of testing mean reversion, only the ratio between.
But traders that pay attention to fundamental values of a stock find stocks that are overpriced this way and sell them, thus dropping the price. Evidence and implications, nber working papers 2343, national bureau of economic research, inc. Cutler d poterba j and summers l speculative dynamics and the. We develop some properties on the autocorrelation of the kperiod returns for the general mean reversion gmr process in which the stationary component is not restricted to the arl process but take the form of a general arma process. This paper contributes to the current brazilian literature in behavioural finance by providing an. Secular mean reversion and longrun predictability of the stock market. New variance ratio tests to identify random walk from the general mean reversion model abstract. Evidence and implications, journal of financial economics 22 october 1988, 2760 with l. A mean reversion process implies a straightforward forecast model.
Poterba and summers 1988 perform variance ratio tests for similarz. Their combined citations are counted only for the first article. Summers 1986, campbell and mankiw 1978, fama and french 1988, lo and mackinley 1988 and poterba and summers 1988 report mean reversion in stock returns over time horizons see footnote 1 less than ten years. This mean or average can be the historical average of the price or return, or. Equilibrium price processes, mean reversion, and consumption smoothing abstract motivated by the empirical observation that there exists some degree of mean reversion in asset prices, this paper investigates the timevarying behaviour of the price of risk in a partial equilibrium framework. This paper investigates behavior in monthly and yearly returns at the dutch stock exchange for the period 1947 1992. See, among others, the studies of fama 1970, summers 1986, poterba and summers. Radkov abstract in this study we investigate using the mean reversion processes in financial risk management, as they provide an good description of stock price fluctuations and market risks. Thaler1985, summers1986, famafrench1988, poterbasummers1988. The first part treats methodological issues involved in testing for transitory return components. Mean reversion refers to a tendency of asset prices to return to a trend path. It demonstrates that variance ratios are among the most powerful tests for detecting mean reversion in stock prices, but that they have little power against the principal interesting alternatives to. Evidence and implications national bureau of economic research, 1050 massachusetts ave. A recentliterature,beginningwith brennan,schwartz,andlagnado1997,camp.
May 15, 2019 mean reversion is the theory suggesting that prices and returns eventually move back toward the mean or average. Poterba and summers 1988 demonstrate that the variance of stock returns is reduced at longer horizons. The evidence for mean reversion over long horizons is weaker if the depression years before world war ii are excluded. He is also the president of the national bureau of economic research, a nonprofit research organization. Fama and french 1988 and poterba and summers 1988 are the rst to doc. The primary case for the existence of long term mean reversion was made in two papers published in 1988, one by james poterba and former us treasury secretary larry summers 1, and the other published by eugene fama and kenneth. Mean reversion is the theory suggesting that prices and returns eventually move back toward the mean or average. Poterba and summers 1988, in which price is the combination of a fair value process whose dynamics are an unpredictable random walk and a meanreversion process transient noise, whose motions tend to selfcorrect.
In this paper, i will propose a stockprice model with meanreverting returns. Poterba is the mitsui professor of economics at mit massachusetts institute of technology. Introduction there have been a large number of studies see among others poterba and summers 1. James michael poterba department of economics, e52444. The larger magnitudes of prices fluctuations due to market. Wealth variability falls as wealth rises black 1976, schwert 1988, 1989, and stock prices show mean reversion fama and french 1988, poterba and summers 1988. It demonstrates that variance ratios are among the most powerful tests for detecting mean reversion in stock prices, but that they have little power against the principal interesting alternatives to the random walk hypothesis. One of us attended a meeting of university endowment managers in the aftermath of the market meltdown of 2008. Mean reversion in equilibrium asset prices stephen g. Summers harvardandnber december1986 revisedaugust1987 wearegratefultobarryperlstein,changyongrhee,jeffzweibelandespecially. Apr 30, 2015 in fact, the changes we need to explain consumption smoothing are precisely the changes we observe. Futher suggested by balvers et al 2000 the differrence. Mean reversion in macro models 2016 academic web pages. The existence of mean reversion in stock prices is subject to much controversy.
Fama and french 1988 and poterba and summers 1988 on mean reversion. Mean reversion across national stock markets and parametric. Mean reversion in stock prices still remains a rather controversial issue. The persistence of volatility and stock market fluctuations. Thaler1985, summers 1986, famafrench1988, poterba summers 1988.
The issues related with mean reversion are addressed using linear. In fact, the changes we need to explain consumption smoothing are precisely the changes we observe. What are the consequences of predictability in returns for portfolio choice. This study extends the investigation of mean reversion price processes by evaluating the existence of mean reversion in the futures prices of seven. In a mean reversion process, price is expected to return to its underlying iliie whenever market forces push the price sufficiently far from this underlying value add summers. Moreover, we may expect the speed of mean reversion to depend on the economic and political environment. Fama and french 1988 measured mean reversion indirectly, by regressing k. The body of academic literature on longterm mean reversion is more tractable than that on shortterm mean reversion. To illustrate this, the mean reversion of a credit default swap cds bulgarian 5y index, is tested using the.
Portfolio and consumption decisions under meanreverting. There is related evidence that stock returns exhibit mean reversion. Both find evidence of mean reversion at some horizons. Whereas theoretical justications for the departure from the random walk model of equity prices have proliferated1, the empirical evidence remains mixed and confusing. Kenneth french as well as james poterba and lawrence summers have managed to detect mean reversion in u. Selection of a portfolio of pairs based on cointegration. However, there appears to be substantial mean reversion in nominal and excess returns over the period 18711925. Investor sentiment in the stock market new york university. Secular mean reversion and longrun predictability of the. Request pdf transitory market states and the joint occurrence of momentum and mean reversion in this article we derive and investigate the implications of the famafrench and poterba. Summers, mean reversion in stock prices previous claims that there are fads in stock prices have typically suggested halflives of several years, implying that the elements in the table corresponding to p12 0. In a mean reversion process, price will return to its underlying value i.
The mean reversion stochastic processes applications in risk management petar r. However, as richardson 1993 points out, the significance of these results must be based onz. James michael poterba department of economics, e52. Mean reversion means that expected return falls as wealth rises. New variance ratio tests to identify random walk from the. Empirical variance ratios of different return horizons are confronted with simulated probability distributions.