Modeling Market Expectations of Profitability Mean Reversion: A Comparative Analysis of Adjustment Models

Miroslava Vlčková () and Tomáš Buus
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Miroslava Vlčková: Faculty of Economics, University of South Bohemia in České Budějovice, Studentská 13, 370 05 České Budějovice, Czech Republic
Tomáš Buus: Faculty of Economics, University of South Bohemia in České Budějovice, Studentská 13, 370 05 České Budějovice, Czech Republic

IJFS, 2025, vol. 13, issue 3, 1-26

Abstract: This paper investigates how market expectations regarding profitability mean reversion are reflected in stock prices. We propose a model that infers implicit expectations of future earnings using publicly available share prices based on the assumption that markets efficiently incorporate forward-looking information. The study compares several adjustment models, including the classical partial adjustment framework and a mean reversion model, to identify the most suitable mechanism to capture the dynamics of expected earnings. Special attention is paid to the statistical characteristics of accounting data and ratio-based measures, which influence model performance. Using a dataset covering a twenty-year period, we find that the mean reversion model consistently outperforms partial adjustment models in explaining the behavior of cyclical and random components converging toward a long-term trend. The findings suggest that market prices embed rational expectations of profitability reversion, especially in periods of above average performance. These results align with previous research and provide a robust framework for understanding how earnings expectations are formed and adjusted in financial markets.

Keywords: comparative analysis; mean reversion; partial adjustment; profitability; transitory earnings (search for similar items in EconPapers)
JEL-codes: F2 F3 F41 F42 G1 G2 G3 (search for similar items in EconPapers)
Date: 2025
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