Mean reversion in the short horizon returns of UK portfolios

Chelley-Steeley, Patricia L. (2001). Mean reversion in the short horizon returns of UK portfolios. Journal of Business Fnance and Accounting, 28 (1-2), pp. 107-126.

Abstract

This paper will show that short horizon stock returns for UK portfolios are more predictable than suggested by sample autocorrelation co-efficients. Four capitalisation based portfolios are constructed for the period 1976–1991. It is shown that the first order autocorrelation coefficient of monthly returns can explain no more than 10% of the variation in monthly portfolio returns. Monthly autocorrelation coefficients assume that each weekly return of the previous month contains the same amount of information. However, this will not be the case if short horizon returns contain predictable components which dissipate rapidly. In this case, the return of the most recent week would say a lot more about the future monthly portfolio return than other weeks. This suggests that when predicting future monthly portfolio returns more weight should be given to the most recent weeks of the previous month, because, the most recent weekly returns provide the most information about the subsequent months' performance. We construct a model which exploits the mean reverting characteristics of monthly portfolio returns. Using this model we forecast future monthly portfolio returns. When compared to forecasts that utilise the autocorrelation statistic the model which exploits the mean reverting characteristics of monthlyportfolio returns can forecast future returns better than the autocorrelation statistic, both in and out of sample.

Publication DOI: https://doi.org/10.1111/1468-5957.00367
Divisions: Aston Business School > Accounting
Additional Information: The definitive version is available at www.blackwell-synergy.com
Uncontrolled Keywords: autocorrelation coefficients,UK portfolios,short horizon returns,mean reversion
Published Date: 2001-01

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