Mean reversion in equity markets

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In Short

It is widely held in the equity market that the variance ratio decreases with a holding period (i.e. longer holding periods equals lower realised variance).

The variance ratio is defined as the annualised volatility measured over a X-day holding period divided by the annualised volatility measured on a daily basis. This has implications for investors seeking to extract the volatility risk premium (holding short volatility positions) in that hedging should be carried out on a less frequent basis to take advantage of this feature, whilst those with long positions should hedge daily to maximise returns.

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