Mean Reversion: Statistical Fact or Dangerous Delusion?
from Aswath Damodaran Hosted by Aswath Damodaran
Much of investing, especially contrarian, is built on the belief that things revert back to norms, either over time or in the cross section. Thus, when you argue that stocks are over priced at a PE of 25, because the historic average is 16, you are buying into mean reversion, just as you when you argue that a steel company trading at 6 times earnings is cheap, because the sector average is 12. While mean reversion is a powerful force, I argue that there is more nuance than we let on, that structural changes can lay waste to it and converting statistical significant to real money is difficult, using the Shiller PE as an illustrative example.Slides: http://www.stern.nyu.edu/~adamodar/pdfiles/blog/MeanReversion.pdfPost: http://bit.ly/2bJzp6k Market timing spreadsheet: http://www.stern.nyu.edu/~adamodar/pc/blog/mkttimingCAPE.xlsx
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