Mean reversion


The idea that stock prices revert to a long term level. Hence, if there is a shock in prices (unexpected jump, either up or down), prices will return or revert eventually to the level before the shock. The time it takes to revert is often referred to as the time to reversion. If the process is very persistent, it might take a long time to revert to the mean. The key difference between a mean-reverting process and a random-walk is that after the shock, the random-walk price process does not return to the old level.

Investing Essentials

Copyright © 2011 Campbell R. Harvey, Professor of Finance, Fuqua School of Business at Duke University

Term of the Day

Acid test ratio

Also called the quick ratio, the ratio of current assets minus inventories, accruals, and prepaid items to current liabilities.

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