Permanent and temporary components of stock prices: a revisit

Our study revisits the seminal work of Fama and French (1988) on mean-reverting behaviour of stock prices. Since then, there are limited studies conducted to attest the results and the methodology implemented by the authors. We use an updated monthly data for the period ranging 1926-2008. As in Fama and French (1988), our findings support the U-shaped patterns of first-order autocorrelations of industries portfolio returns, which implies that stock prices have both random-walk and slowly decaying stationary components. However, the magnitude of the slopes and the time varying expected variance of three to five years return, average between 11 and 16%, decline considerably as compared to 1926-1985 sample period which average between 21 and 31%. The sub-period 1985-2008 has a weaker U-shaped pattern indicating that the stationary price components may be less important after 1985.