Mean reversion in stock prices: implications for long-term investors

Laura Spierdijk and Jacob A. Bikker

Abstract

ABSTRACT

This paper discusses the implications of mean reversion in stock prices for long-term investors such as pension funds. We consider a mean-variance-efficient investor and show how mean reversion in stock prices affects such an investor's optimal portfolio weights. We find that the optimal allocation is not very sensitive to mean reversion and that mean reversion does not reduce portfolio volatility strongly. We discuss the implications of our findings for the investment decisions of long-term investors and, given uncertainty about mean reversion, recommend making conservative assumptions regarding the degree of mean reversion in order to reach the optimal allocation decision.