What is mean reversion in securities trading?


The term mean reversion (average return) refers to the application of the theory of regression to the mean in terms of market price and volatility in the capital market. This relates to the theory that markets are prone to exaggeration, which only corrects over time.

Therefore, a rise will eventually lead to a future decline in price, and vice versa (What goes up, must come down and vice versa). The extreme cases are speculative bubbles. The same applies to volatility and trading volumes. The theory is contrast to the efficient market hypothesis.

Mean reversion in the current means that yield rates and long-term interest rates fluctuate around an average value.

Mean reversion is one of the ways to model the simplification in the Black-Scholes model assumed as constant volatility and is part of several term structure models. Often the modeling of mean reversion relies on stochastic processes, the Ornstein-Uhlenbeck process and the root-diffusion process.

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