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Abstract
This paper investigates whether stock-price indexes of emerging markets can be characterized as random walk (unit root) or mean reversion processes. We implement a panel-- based test that exploits cross-sectional information from seventeen emerging equity markets during the period January 1985 to April 2002. The gain in power allows us to reject the null hypothesis of random walk in favor of mean reversion at the 5 percent significance level. We find a positive speed of reversion with a half-life of about 30 months. These results are similar to those documented for developed markets. Our findings provide an interesting comparison to existing studies on more matured markets and reduce the likelihood of earlier mean reversion findings as attributable to data mining.
JEL Codes: G15, G14, C22
Key Words: Emerging Markets. Mean Reversion, Panel Test
1. Introduction
Researchers in finance have long been interested in the long-run time-series properties of equity prices, with particular attention to whether stock prices can be characterized as random walk (unit root) or mean reverting (trend stationary) processes.1 If stock price follows a mean reverting process, then there exists a tendency for the price level to return to its trend path over time and investors may be able to forecast future returns by using information on past returns. On the other hand, a random walk process implies that any shock to stock price is permanent and there is no tendency for the price level to return to a trend path over time. This suggests that future returns are unpredictable based on historical observations. The random walk property also implies that the volatility of stock price can grow without bound in the long run. These time-series properties are not only of interest by themselves but also have important implications for asset pricing.
The evidence of mean reversion is first documented for the U.S. market. Using U.S. individual firm-level data, DeBondt and Thaler (1985) first report that past losing stocks over the previous 3-5 years significantly outperform past winning stocks over a 3-5 years holding period. Their results indicate that stock prices do not follow a random walk, but contain a strong mean reverting component. Fama and French (1988) also report mean reversion in U.S. equity market using long-horizon regressions,...