Comparison of the Performances for the Mean-Reversion Strategy for Exchange Rate

Abstract

Mean-reversion theory predicts that historical returns and asset price volatility will eventually return to the long-run mean or average level of the entire dataset. The mean-reversion strategy applies the fundamental idea of selling high and attracting low to stock market investment. Researchers studying the international exchange market have shown that foreign exchange rates display momentum and mean reversion behavior. This study aims to assess the effectiveness of the mean-reversion approach on exchange rates and improve it. Using historical data, the author assessed the mean-reversion method's impact on the exchange rate. According to the study, the method offers a risk-to-reward ratio that is conservative. The clear disadvantage is that for most of the exchange rate, mean-reversion methods yield lesser profits. Furthermore, the return is significantly influenced by the mean-reversion lookback period. Quantitatively, exchange rates with significant volatility and variation often outperform when using the mean-reversion approach. Overall, these results shed light on guiding further exploration of mean-revision strategy.