Question

Can you think of a firm that violates the concept of mean reversion? Why do you think this occurs?

Answer 1

Yes a firm of stock market violates the concept of mean reversion .The mean reverting tendency in stock returns points out possibility of prediction of futures returns and consequent abnormal returns.Basically Mean reversion is a financial theory that suggesting asset prices and returns eventually return back to the long-run mean or average of the entire dataset. This mean or average can be the historical average of the price or return, or another relevant average such as the growth in the economy or the average return of an industry.This violates the efficiency market hypothesis (EMH) which states that currency prices fully and instantly reflects information and therefore futures returns are unpredictable. The issue of mean-reversion of stock returns in India was examined using conventional unit root tests only. These tests are known to be less powerful in the presence of structural breaks. The objective of present study is to re-examine the issue of mean-reversion and structural breaks in Indian equity market using more sophisticated test on new disaggregated data.