Anchoring Bias and Mean Reversion: A Duo in Stock Price Dynamics

Mean reversion in the financial market is a concept that suggests that asset prices tend to fluctuate around their long-term average or mean over time. When prices deviate significantly from this mean, they are expected to revert back to it. This phenomenon is often driven by market forces such as investor sentiment, supply and demand dynamics, and economic fundamentals.

Anchoring is a significant cognitive bias in behavioral finance that describes the tendency of individuals to rely heavily on the first piece of information they receive when making decisions. This initial information, often referred to as the "anchor," acts as a reference point that influences subsequent judgments and choices. In financial contexts, anchoring can impact investment decisions when individuals fixate on the purchase price of an asset as the anchor and fail to reassess its value objectively, potentially leading to suboptimal choices.

Reference [1] concurrently examined the impacts of both mean reversion and anchoring bias. The authors investigated the behavior of stock prices concerning their proximity to the 52-week high. They pointed out,

In this study, we examine a novel idea of anchor reversion, which states that large movements away from an anchor are more likely to be followed by movements back toward the same anchor. To explore this hypothesis, we test for a return premium based on movements toward and movements away from the 52-week high, a well-recognized and highly publicized reference point. To the extent that the 52-week high acts as an anchor, then month-over-month movements away from the 52-week high should predict positive future returns. Empirically, we find that movements toward the 52-week high are associated with negative next-month returns and that movements away from the 52-week high are associated with positive next-month returns. These results hold in a portfolio setting with equal- and value-weighted market returns, in cross-sectional Fama and MacBeth (1973) regressions that control for various stock characteristics, and in various sample periods. These findings provide strong empirical support for the notion that the 52-week high can be an anchor that stock prices revert to in the short to intermediate term.

In short, the paper showed that stock prices tend to revert to the 52-week high as a short to intermediate-term anchor.

We find the results intriguing. However, we are unsure of the authors' exact meaning when they refer to "the price moving away from/toward the 52-week high." Specifically, we are uncertain about the direction of this movement, whether it is upward or downward.

Let us know what you think in the comments below or in the discussion forum.

References

[1]  Benjamin M. Blau, Todd G. Griffith, Ryan J. Whitby & Darren Woodward, Anchor Reversion: The Case of the 52-Week High and Asset Prices, 2023, Journal of Behavioral Finance, DOI: 10.1080/15427560.2023.2244103

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