Dynamic Mean Reversion of Stock Prices: Evidence from Amman Stock Exchange

Dima Waleed Hanna Alrabadi

Abstract


This study aims to investigate the relative mean reversion process of stock prices in Amman stock exchange using daily data over the period (2004-2013). Symmetric and asymmetric versions of the partial adjustment model are utilized to achieve the objectives of the study. The simple model of mean reversion, which is commonly used to estimate the speed of mean reversion, is extended to a single equation Error Correction model (ECM), which accounts for both short and long term effects. The results show that stock prices significantly but very slowly move toward their fundamental values. The adjustment rate is 9% indicating that 7 days are required to eliminate half of the deviation of the actual stock price from the fundamental value. The asymmetric partial adjustment model shows that the adjustment coefficient is higher for prices above their fundamental values (31%) than for prices below their fundamental values (15%), thus the stock prices are slower when the adjustment requires an increase in price level than a decrease in price level. Finally, the ECM shows that stock prices change their actual values relative to the long-run fundamental value but in a slow manner.


Keywords


Partial Adjustment Model, Mean Reversion, Stock Prices, Error Correction Model, Amman Stock Exchange.

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