Mean-Reversion Across MENA Stock Markets: Implications for Portfolio Allocations

Are stock market returns mean-reverting in the region? Mean reversion in a stock market suggests that bad returns are likely to be followed by periods of good returns. By contrast, in a random walk setting, the future is a flip of a coin, regardless of the return outcomes in earlier periods.  An important implication to our findings is that because MENA stock returns exhibit mean reversion, the volatility of returns would be lower than that implied by a random walk model. Using recent stock market data between 1995 and 2000 on Egypt, Jordan, Morocco, and Turkey we find evidence of mean reversion and introduce a non-parametric model to estimate the reverting mean and speed of reversion.  Monte Carlo simulations demonstrate how the volatility of stock returns is dampened by a high speed of reversion.  Our results have an important bearing on the pricing of equity derivatives in MENA and are useful for investors employing tactical asset allocation strategies.