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Class Year

2019

Abstract

Mean reversion in stock prices is a highly studied area in the financial literature with controversial findings. While some economists have found evidence of mean reverting processes in stock prices, many argue in favor of the Efficient Market Hypothesis which states stock prices are random walk processes. This paper seeks to add to the literature on mean reversion but testing for evidence in price-earnings ratios rather than stock prices. The study employs a robust regression model controlling for company-specific and general market factors that influence price-earnings ratio deviations. After correcting for heteroskedasticity, serial correlation, and unit root processes, the results indicate mean reverting behavior does exist in US equities from 2008- 2017 and mean reversion in price-earnings ratios may occur more quickly than mean reversion of stock prices. The outcome of this paper also implies some level of endogeneity in the Three-Factor-Model proposed by Fama and French (1992).

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