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Do Mean Reverting based trading strategies outperform Buy and Hold?

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  • Dooruj Rambaccussing

    (University of Exeter)

Abstract

If prices of assets are not aligned to their net present value, a trading strategy may be implemented when actual prices revert to fundamentals. This hypothesis is informally tested in real-time using a trading strategy which consists of identifying whether the equity index is over or under- priced. The fundamental price is constructed in real time using the net present value approach which requires the series for expected dividends, expected returns and expected dividend growth rate. These series, typi- cally unobservable, are derived from a structural state space model and econometric models. The performance of the rules depend on the fre- quency of the data. Cyclical behaviour within the the one year frequency may not be discarded. The trading strategy performs poorly implying that mean reversion may not be uncovered in real-time. However a hybrid variant of the structural and econometric model is shown to outperform the passive Buy and Hold strategy.

Suggested Citation

  • Dooruj Rambaccussing, 2011. "Do Mean Reverting based trading strategies outperform Buy and Hold?," Working Papers 1113, Department of Applied Economics II, Universidad de Valencia.
  • Handle: RePEc:eec:wpaper:1113
    as

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    File URL: ftp://147.156.210.157/RePEc/pdf/eec_1113.pdf
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    References listed on IDEAS

    as
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    9. Caporale, Guglielmo Maria & Gil-Alana, Luis A., 2004. "Fractional cointegration and tests of present value models," Review of Financial Economics, Elsevier, vol. 13(3), pages 245-258.
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    More about this item

    Keywords

    Trading Rule; Asset Pricing; State Space Modeling;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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