Mean Reversion Framework
27 Pages Posted: 20 May 2015 Last revised: 8 Jun 2022
Date Written: May 19, 2015
The original work by Galton on mean reversion in 1886 emphasized relative before absolute, talked about the relation of the variable with the sample average, pointed out the balance between convergence and divergence and showcased cross-domain expression of mean reversion. Though mean reversion as an idea has been in the open domain for 130 years, there has been no attempt to extend the Galtonian definition of natural systems into a framework that could allow for better understanding and functioning of natural systems and also explain the failures of reversion. Any proxy that expresses Galtonian reversion should be simple, relative and universal. This paper takes a stock market case and defines a framework that builds on the Galtonian explanation of a natural system and incorporates the idea of relative ranking, relative average, balancing forces of convergence and divergence, and the universal workability of the framework across domains.
Keywords: Francis Galton, Mean Reversion, Divergence, Relative Performance, Natural Systems
JEL Classification: C10
Suggested Citation: Suggested Citation