Testing asymmetry in mean reversion based on high and low prices: Evidence from BRICS countries

• Published date: 01 May 2022
• Author: Mukta Kanvinde,Muneer Shaik
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2443

ACADEMIC PAPER

Testing asymmetry in mean reversion based on high and low

prices: Evidence from BRICS countries

Mukta Kanvinde | Muneer Shaik

Department of Finance, IFMR Graduate

School of Business, SriCity, India

Correspondence

Mukta Kanvinde, Department of Finance,

IFMR Graduate School of Business, 5655,

Central Expressway, SriCity 517646, Andhra

Pradesh, India.

Email: mukta.kanvinde@ifmr.ac.in

Shaik and Maheswaran (2018) proposed the Expected Lifetime Range (ELR) ratio

based on high minus low price (range) series to detect mean reversion. This paper

extends this test statistic and proposes a set of test statistics—Expected Lifetime Sur-

plus (ELSp) and Expected Lifetime Shortfall (ELSf) ratios—which are based on high

and low price series respectively. These test statistics help in precisely detecting

whether the source of market inefficiency is the high or the low price series. The

paper empirically tests the three test statistics on the BRICS stock market indices.

The sample period is divided into pre and post subprime crisis data sets. It is found

that the BRICS stock market indices show mean reversion from 2001 to 2018. While

in the pre subprime crisis period the indices followed random walk, after the sub-

prime crisis the BRICS stock markets show mean reversion behavior. The source of

this mean reversion are the high prices which have become more predictable after

the subprime crisis.

1|INTRODUCTION

The behavior of the stock prices has fascinated the finance world

since the establishment of stock markets. Of all the theories prop-

ounded to solve the mystery of the stock price movements, the Effi-

cient Market Hypothesis (EMH) has gained the maximum interest

over the past 50 years. A key assumption of this theory is that, stock

prices display random walk behaviour.

However, there has been no clear consensus on whether the

stock prices truly move randomly as academicians and professionals

have used various methodologies on different data periods to test for

random walk behavior.

Shaik and Mahe swaran (2018) developed Expected Lifetime Range

(ELR) Ratiotest statistic to detectthe presence of mean reversionbased

on high minus lowprice (range) series. They theoretically demonstrated

the superiority of the ELR ratio (which is based on the linear combina-

tion of high and lowprices) over Lo and MacKinlay (1988) (LM) variance

ratio test in detecting the presence of mean reversion. This paper

extends the work by developing test statistics which use high and low

price individually to detectpresence of mean reversionin those specific

price series.This paper develops a new test statistic, “ExpectedLifetime

Surplus Ratio(ELSp)”to detect the presence of mean reversion in stock

index returns based on the daily high prices and “Expected Lifetime

Shortfall Ratio (ELSf)”a test statistic based on dailylow prices of stock

indices. This test statistic can also detect any asymmetry in the mean

reversion pattern of the series with regards to high prices and low

prices. Asymmetry in mean reversion is defined as, “high prices dis-

playing meanreversion while low prices showrandom walk behavior or

vice versa.”This test statistic is used to studythe behavior of the stock

indices of BRICS countries viz. Ibovespa Brasil Sao Paolo stock

exchange Index(IBOV) of Brazil, MOEX Russia Index (MOEX)of Russia,

NSE Nifty 50 Index (NIFTY) of India,Shanghai stock exchangeCompos-

ite Index (SHCOMP) of China, and FTSE/JSE Africa All Share Index

(FTSE/JSE) of South Africa and compare the changes in their behavior

in the period before (January 2001–December 2007) and after (June

2009–June 2018) the global financial crisis of 2008. It is found that

there is asymmetry between high prices and low prices in terms of

mean reversion and that the stock markets are prone towards over

reaction(De Bondt & Thaler, 1985).

The rest of the paper is organized as follows. Section 2briefly

reviews the literature on this topic. Section 3, explains the methodol-

ogy of ELR ratio and propose the ELSp and ELSf ratio test statistics.

Section 4, describes the data set analyzed in this study. Section 5,

shows the empirical evidence based on the data on the presence of

mean reversion in the selected stock markets. Section 6, concludes

the article with a summary of the main findings.

Received: 25 June 2020 Accepted: 22 August 2020

DOI: 10.1002/pa.2443

J Public Affairs. 2022;22:e2443. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of11

https://doi.org/10.1002/pa.2443