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TL;DR

The tendency of a time series to return toward its long-run average. Formally, a process is mean-reverting if its drift is negative when above the mean and positive when below.

By Valenke Exam Prep Team·Last updated 2026-06-03

Mean Reversion

The tendency of a time series to return toward its long-run average. Formally, a process is mean-reverting if its drift is negative when above the mean and positive when below.

Why it matters for interviews

Mean reversion is the basis for pairs trading, statistical arbitrage, and interest rate models. Testing for mean reversion (ADF test, Hurst exponent) and estimating its speed are core quantitative skills.

Definition and Mathematical Foundation

The tendency of a time series to return toward its long-run average. Formally, a process is mean-reverting if its drift is negative when above the mean and positive when below.

Application in Quantitative Finance

Mean reversion is the basis for pairs trading, statistical arbitrage, and interest rate models. Testing for mean reversion (ADF test, Hurst exponent) and estimating its speed are core quantitative skills.

Related Terms

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Frequently Asked Questions

How do you test for mean reversion?▼
The Augmented Dickey-Fuller (ADF) test checks if a time series has a unit root (not mean-reverting) vs. stationary (mean-reverting). The Hurst exponent H < 0.5 suggests mean reversion; H > 0.5 suggests trending.
What is cointegration and how does it relate?▼
Two non-stationary series are cointegrated if a linear combination is stationary (mean-reverting). This is the foundation of pairs trading: the individual assets may trend, but their spread reverts.
Is mean reversion inconsistent with market efficiency?▼
Not necessarily. Mean reversion in spreads is consistent with no-arbitrage if the reversion compensates for risk. Short-term mean reversion in individual stocks (driven by microstructure) is well-documented and consistent with market-making activity.