Abstract
The objective of this research is to examine and compare the mean reversion phenomenon in developed and emerging stock markets. An important aim is to measure and compare the speed of mean reversion and half-life of volatility shocks of emerging and developed markets. For this purpose, we have selected five developed and seven emerging markets, and used daily market indices for the period of 1 January 2000 to 30 June 2016. We employed autoregressive conditional heteroskedasticity – Lagrange multiplier (A.R.C.H.-L.M.), generalised autoregressive conditional heteroskedasticity (G.A.R.C.H.) (1, 1), and half-life volatility shock techniques to carry out this research. The results of the study confirmed the mean-reverting process in developed and emerging markets. The South Korean market has the slowest mean reversion, and thus has the highest comparative volatility over a longer period of time. However, the Pakistan stock exchange exhibited the fastest mean reverting process. It is also concluded that the relative volatilities are higher in emerging markets, whereas the comparative volatilities are higher in developed markets. Therefore, it is further concluded that the mean reversion process is much faster in emerging indices except the South Korean and Chinese markets. The study recommends that if investors want higher returns in a shorter period of time then they should invest in emerging markets.
Highlights
It is further concluded from the results that all the emerging and developed markets observe a mean reverting process because the sum of A.R.C.H. and G.A.R.C.H. is less than 1
The results of the study indicate that all 12 emerging and developed stock markets have exhibited the presence of the mean reversion process
The results of the study demonstrate that the developed markets are more stable and less volatile as compared to the emerging markets; the developed equity markets observe the slowest mean reversion with the highest comparative volatility against the emerging markets. It is further concluded from the results that all the emerging and developed markets observe a mean reverting process because the sum of A.R.C.H. and G.A.R.C.H. is less than one
Summary
The asset-pricing model has been a paramount feature for the equity prices since the 1970s. Keeping in mind the basic idea that ‘what goes up must come back down’, De Bondt and Thaler (1985) proposed the postulate of mean reversion This theory refers the historic mean values of the stock prices and is known as the mean reverting process. According to this theory that there is a tendency of returns to come back its past mean value after a certain time period. Fama and French (1988) have carried out a study to confirm the mean reversion phenomenon, and they studied the memory pattern in stock returns They concluded that the past prices predict the future values of stocks, and this is the proof of memory pattern that supports the postulate of a mean reversion process. According to the previous literature, long-term mean reversion can be examined by using two different methods, termed as relative mean reversion and absolute mean reversion (Slim et al, 2017; Trypsteen, 2017)
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