An empirical study of mean reversion in international stock market indexes and the implications for the FTK continuity test

This thesis considers three different issues regarding long-term mean reversion in stock prices.First, the literature on long-term mean reversion is reviewed by introducing a dichotomy in which a distinction is made between absolute mean reversion and relative mean reversion.Second, the empirical evidence of relative mean reversion in international stock indexes, found by Balvers et al. (2000), is examined by (i) enlarging the number of years to the interval 1900to 2008, and (ii) introducing a bootstrap method to correct for the small sample bias in the test statistic. This thesis finds mean reversion, however at a much longer term than suggested by Balvers et al. (2000). Moreover, significant fluctuations of the mean reversionprocess across time undermines the usefulness of long-term mean reversion. Third, the effect of mean reversion on the FTK continuity analysis is examined. Also an advice regarding the regulation on mean reversion in the continuity analysis is provided.