Momentum and Mean Reversion in a Semi-Markov Model for Stock Returns

39 Pages Posted: 31 Dec 2021 Last revised: 9 Mar 2022

See all articles by Javier Giner

Javier Giner

University of La Laguna - Faculty of Economics, Business and Tourism

Valeriy Zakamulin

University of Agder - School of Business and Law

Abstract

A vast body of empirical literature documents the existence of short-term momentum and medium-term mean reversion in various financial markets. By contrast, there is still a great shortage of theoretical models that explain the presence of these two common phenomena. We develop a semi-Markov model where the return process randomly switches between bull and bear states. In our model, the state duration times are governed by a negative binomial distribution that exhibits a positive duration dependence. We demonstrate that this model induces return momentum at short lags and reversal at subsequent lags. We calibrate our model to empirical data and show that the model-implied autocorrelation function fits reasonably well to the empirically estimated autocorrelation function.

Keywords: time-series momentum, mean reversion, bull and bear markets, duration dependence, semi-Markov model

Suggested Citation

Giner, Javier and Zakamulin, Valeriy, Momentum and Mean Reversion in a Semi-Markov Model for Stock Returns. Available at SSRN: https://ssrn.com/abstract=3997837 or http://dx.doi.org/10.2139/ssrn.3997837

Javier Giner

University of La Laguna - Faculty of Economics, Business and Tourism ( email )

Camino La Hornera s/n
La Laguna, Tenerife, 38071
Spain
+34 922317102 (Phone)

Valeriy Zakamulin (Contact Author)

University of Agder - School of Business and Law ( email )

Service Box 422
Kristiansand, N-4604
Norway
+47 38141039 (Phone)

HOME PAGE: http://vzakamulin.weebly.com/

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