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Research in Focus: Mean Reversion in Dimensions of Stock Returns

Research in the world’s financial markets has documented the existence of equity, size, value, and profitability premiums in the historical sample of stock returns. Since these premiums have been persistent across long time periods and pervasive across various markets, they are sometimes called dimensions of expected stock returns. While the evidence indicates that the averages for these premiums have been reliably positive, their annual realizations have varied substantially. This variation naturally leads some to wonder if the expected values of these premiums are constant over time. In particular, some have speculated that there may be mean reversion in the time series of the premiums, so that high premiums tend to be followed by low premiums and vice versa.

Can investors predict when to buy and sell securities? In this short video Jim Davis, PhD, runs more than 780 tests on data from 15 stock markets to test this theory.