Mean reversion

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This is the assumed tendency for a stochastic process to remain near to, or to return over time towards, a long-run average.

In a simple mean reverting process, the correlation coefficient between successive periods' price movements is negative.

In other words, there is a greater probability that a subsequent price movement will be in the opposite direction from the previous period's movement (rather than in the same direction as the previous period).

Interest rates, implied volatilities and stock market returns are believed by many people to exhibit mean reversion, but exchange rates and stock prices are generally believed not to do so.

Another view is that certain markets are mean-reverting in relation to small changes in market prices or rates, and trending in relation to larger changes in market prices or rates.

This view is reflected in leptokurtic probability distributions and the volatility smile in option values.

See also