Temporary Movements in Stock Prices

Abstract

Mean reversion in stock prices is stronger than commonly believed. I show that 1-, 3-, and 5-year returns are negatively related to future returns over the subsequent 12 to 18 months. Reversals in 1- year returns are the most reliable, with strong significance in both the full 1926 - 1998 sample and the more recent 1946 - 1998 period. The reversals are also economically significant. The full-sample evidence suggests that 25% to 45% of annual returns are temporary, reversing within 18 months. The percentage drops to between 20% and 30% after 1945. Mean reversion appears strongest in larger stocks and can take several months to show up in prices.