Speed of mean reversion: an empirical analysis of KSE, LSE and ISE indices
Abstract
The purpose of this study is to determine the presence of mean reversion in the stock markets indices of Pakistan, moreover, to measure, and compare the speed of mean reversion of the stock markets indices across Pakistan. In order to carry out the research study, the daily data of three stock indices of Pakistan such as: KSE-100, LSE-25 and ISE-10 are collected from 2003 to 2014. After the application of tests such as ARCH and GARCH, it was found that returns series of KSE-100, LSE-25 and ISE-10 indices exhibit mean reversion, indicating that the returns revert back to their historical value after reaching an extreme value. Further, the mean reversion rate shows that KSE-100 index has the slowest mean reversion, however, the ISE-10 index has the fastest mean reversion among the three indices. Therefore, the results of the study concluded that KSE-100 index, due to the slowest mean reversion rate has higher volatility over a longer period of time. On the contrary, since, ISE-10 index has exhibited the fastest mean reversion with the lowest volatility as compared to others. But due to fast mean reversion rate, it will help investors to gain profits over a shorter period of time. Thus, it can be recommended that the investor willing to bear the risk of time and looking for long-term investment should invest in KSE-100 index. However, investors looking for higher profits in a shorter period can invest in the ISE-10 index but with higher risk-returns trade-off.
Keyword : mean reversion, stock indices, ARCH & GARCH, KSE100, LSE25, ISE10
How to Cite
Palwasha, R. I., Ahmad, N., Ahmed, R. R., Vveinhardt, J., & Štreimikienė, D. (2018). Speed of mean reversion: an empirical analysis of KSE, LSE and ISE indices. Technological and Economic Development of Economy, 24(4), 1435-1452. https://doi.org/10.3846/20294913.2017.1342286
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Chaudhuri, K.; Wu, Y. 2003. Mean reversion in stock prices: evidence from emerging markets, Managerial Finance 29(10): 22–37. https://doi.org/10.1108/03074350310768490
Chaves, D. B.; Viswanathan, V. 2016. Momentum and mean-reversion in commodity spot and futures markets, Journal of Commodity Markets 3(1): 39–53. https://doi.org/10.1016/j.jcomm.2016.08.001
Chen, Q.; Jiang, Y.; Li, Y. 2012. The state of the market and the contrarian strategy: evidence from China’s stock market, Journal of Chinese Economic and Business Studies 10(1): 89–108. https://doi.org/10.1080/14765284.2012.638473
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Chi, Z.; Dong, F.; Wong, H. Y. 2016. Option pricing with threshold mean reversion, Journal of Futures Markets 37(2): 107–137. https://doi.org/10.1002/fut.21795
DeBondt, W. F. M; Thaler, R. 1985. Does the stock market overreact, Journal of Finance 40(3): 793–805. https://doi.org/10.1111/j.1540-6261.1985.tb05004.x
Dickey, D. A.; Fuller, W. A. 1979. Distribution of estimators for autoregressive time series with a unit root, Journal of the American Statistical Association 74(366a): 427–431. https://doi.org/10.1080/01621459.1979.10482531
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Engle, R. 2001. GARCH 101: the use of ARCH/GARCH models in applied econometrics, Journal of Econometric Perspectives 15(4): 157–168. https://doi.org/10.1257/jep.15.4.157
Fama, E. F.; French, K. R. 1988. Permanent and temporary components of stock prices, Journal of Political Economy 95(2): 246–273. https://doi.org/10.1086/261535
García, F.; González-Bueno, J. A.; Oliver, J. 2015. Mean-variance investment strategy applied in emerging financial markets: evidence from the Colombian stock market, Intellectual Economics 9(1): 22–29. https://doi.org/10.1016/j.intele.2015.09.003
Gimpel, H. 2007. Preferences in negotiations: the attachment effect. New York: Springer Science & Business Media.
Goudarzi, H. 2013. Volatility mean reversion and stock market efficiency, Asian Economic and Financial Review 3(12): 1681–1692 [online], [cited 22 March 2015]. Available from Internet: http://www.aessweb.com/pdf-files/aefr%203(12),%201681-1692.pdf
Hakim, S.; Neaime, S. 2003. Mean-Reversion across mena stock markets: implications for portfolio allocations, International Journal of Business 8(3).
Hart, C. E.; Lence, S. H.; Hayes, D. J.; Jin, N. 2015. Price mean reversion, seasonality, and options markets, American Journal of Agricultural Economics 98(3): 707–725. https://doi.org/10.1093/ajae/aav045
Henderson, T. M. 2004. Fixed income strategy: a practitioner’s guide to riding the curve. John Wiley & Sons.
Hillebrand, E. 2003. Mean reversion model of financial markets. Bremen: University of Bremen.
Huggins, D.; Schaller, C. 2013. Fixed income relative value analysis: a practitioners guide to theory, tools and trades. John Wiley & Sons Inc.
İzgi, B.; Duran, A. 2016. 3D extreme value analysis for stock return, interest rate and speed of mean reversion, Journal of Computational and Applied Mathematics 297: 51–64. https://doi.org/10.1016/j.cam.2015.10.009
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Kim, M. J.; Nelson, C. R.; Startz, R. 1991. Mean reversion in stock prices? A reappraisal of empirical evidence, The Review of Economic Studies 58(3): 515–528 [online], [cited 23 March 2015]. Available from Internet: http://www.e-m-h.org/KiNS91.pdf
Kühnlenz, S. 2014. Economic bubbles: a story of new eras, emotional contagion and structural support. Anchor Academic Publishing.
Lal, I.; Mubeen, M.; Hussain, A.; Zubair, M. 2016. An empirical analysis of higher moment capital asset pricing model for Karachi Stock Exchange (KSE), Open Journal of Social Sciences 4(6): 53–60. https://doi.org/10.4236/jss.2016.46006
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Lo, A. W.; MacKinlay, A. C. 1988. Stock market prices do not follow random walk: evidence from a simple specification test, The Review of Financial Studies 1(1): 41–66. https://doi.org/10.1093/rfs/1.1.41
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Lubnau, T.; Todorova, N. 2015. Trading on mean-reversion in energy futures markets, Energy Economics 51: 312–319. https://doi.org/10.1016/j.eneco.2015.06.018
MacKinnon, J. G. 1996. Numerical distribution functions for unit root and cointegration, Journal of Applied Econometrics 11(6): 601–618. https://doi.org/10.1002/(SICI)1099-1255(199611)11:6<601::AID-JAE417>3.0.CO;2-T
Malkiel, B. G. 2003. The efficient market hypothesisand its critics [online], [cited 26 March 2015]. Princeton University. Available from Internet: https://www.princeton.edu/~ceps/workingpapers/91malkiel.pdf
Malliaropulos, D.; Priestley, R. 1996. Mean reversion in Southeast Asian stock markets, Journal of Empirical Finance 6(4): 355–384. https://doi.org/10.1016/S0927-5398(99)00010-9
Manzana, S. 2007. Nonlinear mean reversion in stock prices, Quantitative and Qualitative Analysis in Social Sciences 1(3): 1–20 [online], [cited 26 March 2015]. Available from Internet: http://qass.org.uk/2007/vol1_3/paper_1-manzan.pdf
Mtunya, A. P.; Ngare, P.; Nkansah-Gyekye, Y. 2016. On steady dividend payment under functional mean reversion speed, Journal of Mathematical Finance 6(3): 368–377. https://doi.org/10.4236/jmf.2016.63030
Mustafa, K.; Ahmed, R. 2013. The random walk model in the Karachi Stock Market: an empirical investigation, Journal of Economics and Sustainable Development 4(3): 262–278 [online], [cited 27 March 2015]. Available from Internet: http://www.academia.edu/4747822/The_Random_Walk_Model_in_the_Karachi_Stock_Market_An_Empirical_Investigation
Narayan, P. K.; Narayan, S. 2007. Mean reversion in stock prices: new evidence from panel unit root tests, Studies in Economics and Finance 24(3): 233–244. https://doi.org/10.1108/10867370710817419
Narayan, P. K.; Smyth, R. 2006. Are OECD stock prices characterized by a random walk? Evidence from sequential trend break and panel data models, Applied Financial Economics 15(8): 547–556. https://doi.org/10.1080/0960310042000314223
Neaime, S. 2015. Are emerging MENA stock markets mean reverting?, A Monte Carlo simulation, Finance Research Letters 13: 74–80. https://doi.org/10.1016/j.frl.2015.03.001
Oikarinen, E.; Schindler, F. 2015. Momentum and mean reversion in regional housing markets: evidence from variance ratio tests, International Journal of Strategic Property Management 19(3): 220–234. https://doi.org/10.3846/1648715X.2015.1031854
Okpara, G. C. 2010. Stock market prices and the random walk hypothesis: further evidence from Nigeria, Journal of Economics and International Finance 2(3): 49–57 [online], [cited 28 March 2015]. Available from Internet: https://www.researchgate.net/profile/Godwin_Okpara/publica-tion/228614312_Stock_market_prices_and_the_random_walk_hypothesis_Further_evidence_from_Nigeria/links/00b7d523409d4cbb17000000.pdf
Poon, S.-H. 2005. A practical guide to forecasting financial market volatility. John Wiley & Sons.
Poshakwale, S. 2003. The random walk hypothesis in the emerging Indian Stock Market, Journal of Business Finance & Accounting 29(9–10): 1275–1299.
Poterba, J. M.; Summers, L. H. 1987. Mean reversion in stock prices: evidence and implications [online], [cited 29 March 2015]. The National Bureau of Economic Research. Available from Internet: http://dspace.mit.edu/bitstream/handle/1721/63837/meanreversionins00pote.pdf?sequence=1
Riaz, T. 2014. Mean reversion in stock prices: evidence from Karachi Stock Exchange, World Academy of Science, Engineering and Technology, International Science Index, Economics and Financial Engineering 2(2): 657.
Saeedi, A.; Miraskari, S. R.; Ara, M. S. 2012. The investigation of efficient market hypothesis: evidence from an emerging market, The Asian Business and Management Conference, 363–377. Osaka: The international Academic Forum.
Serletis, A.; Rosenberg, A. A. 2009. Mean reversion in the US stock market, Chaos, Solitons & Fractals 40(4): 2007–2015. https://doi.org/10.1016/j.chaos.2007.09.085
Shaffer, D. S. 2010. Profiting in economic storms: a historic guide to surviving depression, deflation, hyperinflation, and market bubbles. John Wiley & Sons.
Spierdijk, L.; Bikker, J. 2012. Mean reversion in stock prices: implication for long term investors [online], [cited 30 March 2015]. Amsterdam: De Nederlandsche Bank. Available from Internet: http://www.dnb.nl/en/binaries/Working%20Paper%20343_tcm47-271856.pdf
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