Mean reversion in investment markets: the implications for investors and regulators

This paper is particularly concerned with mean reversion in investment markets and its implications for investment market regulation. It is now well established that equity markets reflect a varying risk premium. It also seems that they and other investment markets are not necessarily always efficient and can sometimes move to extreme levels. Investors who rely on fundamental analysis of individual assets and asset classes can profit from such movements. Uninformed investors, on the other hand, can not only lose money by inadequate diversification and excessive trading, but also by being panicked into buying overpriced or selling under priced assets. This leads on to a consideration of other errors, identified by recent research, to which uninformed investors may be prone. Most important would appear to be the failure of superannuation members to adapt their investment strategy over their lifetimes. It is suggested that official and industry regulators should take behavioural finance insights into account in enforcing disclosure, and by encouraging a more thorough approach to the monitoring of investment performance. The pressure on uninformed and nervous investors to panic might be reduced by the publication of a consensus portfolio to act as a benchmark.