The impact of mean reversion model on portfolio investment strategies: An application on the emerging markets

Mean Reversion Model is a model which assumes that stock prices have average value and prices will definitely reach this value. On the validity of mean reversion model in stock prices, investors can predict current and future prices by using past prices of stocks and so investors select portfolio investment strategies which provide the highest returns. For this reason, the selection of best portfolio investment strategy in the validity of mean reversion model draws great interest of researchers.The aim of this paper is to test the validity of mean reversion model and to determine which portfolio investment strategy shows the best performance on the existence of mean reversion in emerging markets. For this purpose, the validity of mean reversion model is tested by using panel regression analysis for the period between 1995-2010 for 18 emerging market and using monthly stock market index data. After determining the validity of mean reversion model, the best performing portfolio investment strategy is investigated by using contrarian, momentum and buy and hold portfolio investment strategies. In conclusion, it is found that mean reversion model is valid in all emerging markets and the most succesful strategy is contrarian portfolio investment strategy on the validity of mean reversion model. According to contrarian strategy, investor will buy the stock that are undervalue and sell short when they are overvalued. On the validity of mean reversion model, it is common to expect that investors increase return by acting oppositely with market trend. This finding also supports that emerging markets are not weak form efficient. The findings of the paper is important for investors, financial markets and academicians.Key Words: Mean Reversion Modelling, Portfolio Investment Strategies, Emerging Markets