Mean reversion

The tendency of a variable to drift back towards a long-run level. Interest rates and volatility are often modelled this way.

Where you will meet it

Mean reversion comes up in 13 learning outcome notes across the FRM syllabus. A few of them:

• Stationary Time Series
  FRM Part I · Quantitative analysis

  “Mean reversion means a stationary series is pulled back toward a fixed long-run level, so deviations from it fade over time rather than persisting.”

• Measuring and Monitoring Volatility
  FRM Part I · Valuation and risk models

  “Positive autocorrelation makes it understate, and mean reversion in volatility makes it misstate.”

• Empirical Properties of Correlation: How Do Correlations Behave in the Real World?
  FRM Part II · Market risk measurement and management

  “Mean reversion in correlation has a speed a, a long-run level μ and a time step dt.”

• Factors
  FRM Part II · Risk management and investment management

  “Volatility is persistent but mean-reverting and jumps, so rules react after losses and can sell low and rebuy high.”

See also

Volatility

All terms beginning with M · FRM glossary

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