PP Returns

[moda0306]

I was a little curious about what seemed to be a reversion to a mean with the PP.  The PP tends to usually correct itself pretty quickly for any lack of performance.

I looked at series of years where the PP had single- or double-digit performance, and how the PP did in the year immediately following. Here's what I found (using Craig's historical PP performance):

Average return after 3 years of double-digit returns: 2.2%
Average return after 2 years of double-digit returns: 6.68%
Average return after 1 year of double-digit returns: 8.56%
Average return after 1 year of single-digit returns: 10.86%
Average return after 2 years of single-digit returns: 11.44%
Average return after 3 years of signle-digit returns: 10.5%
Average return after 4 years of single-digit returns: 14%

As you can see, there is quite the trend of reverting to a mean, and it's even more pronounced when there are more years of either very good or poor performance in a row.  Keep in mind, if we eek out a double digit return in 2011 that will be 2 years of double digit returns in a row.  This has a following-year average of 6.68%, and only during the 70's did we see any three-year runs of double digit returns.  One of those was followed by the infamous 3.9% drop.

This might factor into someone's VP considerations.  Also, to consider, is the level of inflation during the time you are looking at.  Obviously, 10% return in 1978 is different than in 1998.

[TripleB]

I think the PP benefits from volatility, because of rebalancing. Always buying low and selling high.

Thus the reversion to the mean would be caused by a reduction in volatility. This makes sense because huge volatility is unlikely to last long periods of time.

Maybe we can use the VIX compared to PP returns to see if there's anything interesting?

[dragoncar]

Somebody build the markov chain