Mean Reversion and the Predictability of the Stock Market
Presentation Type
Oral Presentation
Keywords
Mean Reversion, Price-to-Earnings Ratio, Investment Strategy
Department
Business Administration
Major
Business Administration
Abstract
Mean reversion refers to the tendency of asset prices to return to a long term trend. The existence of mean reversion in indexes implies predictability and predictability can be exploited by constructing investment strategies that may have the potential to outperform benchmarks. Mean reversion in stock prices in the U.S. has been a subject to much controversy and there is no strong evidence in favor for or against it. However, evidence of mean reversion exists in certain stock fundamentals, such as the Price-to-Earnings ratio (P/E). That is, the stock prices may or may not mean revert, but the relative stock prices (relative to companies’ earnings) do exhibit mean reversion. In our research we worked to see if we could capitalize on this mean reversion. We analyzed well-diversified data, including indexes with stocks from all over the globe, comparing an investment strategy based on assumed predictability to the standard buy-and-hold approach. Our findings suggest that investing under the assumption of mean reversion in Price-to-Earnings ratios does in fact, on average, outperform the benchmark—increasingly so as you move into the long run.
Faculty Mentor
Levon Goukasian
Funding Source or Research Program
Undergraduate Research Fellowship
Presentation Session
Session B
Location
Plaza Classroom 189
Start Date
1-4-2016 5:30 PM
End Date
1-4-2016 5:45 PM
Mean Reversion and the Predictability of the Stock Market
Plaza Classroom 189
Mean reversion refers to the tendency of asset prices to return to a long term trend. The existence of mean reversion in indexes implies predictability and predictability can be exploited by constructing investment strategies that may have the potential to outperform benchmarks. Mean reversion in stock prices in the U.S. has been a subject to much controversy and there is no strong evidence in favor for or against it. However, evidence of mean reversion exists in certain stock fundamentals, such as the Price-to-Earnings ratio (P/E). That is, the stock prices may or may not mean revert, but the relative stock prices (relative to companies’ earnings) do exhibit mean reversion. In our research we worked to see if we could capitalize on this mean reversion. We analyzed well-diversified data, including indexes with stocks from all over the globe, comparing an investment strategy based on assumed predictability to the standard buy-and-hold approach. Our findings suggest that investing under the assumption of mean reversion in Price-to-Earnings ratios does in fact, on average, outperform the benchmark—increasingly so as you move into the long run.