The profitability of pairs trading strategies: distance, cointegration and copula methods

Rad, Hossein; Low, Rand Kwong Yew; Faff, Robert W.

doi:10.1080/14697688.2016.1164337

Cited by 110 publications

(50 citation statements)

References 34 publications

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“…Rad et al . () find monthly excess returns of 0.83% prior to transaction costs for the cointegration approach—very similar to the 0.88% return of the distance method they run as benchmark. This lack of outperformance of the cointegration approach is possibly driven by the two‐step pairs selection metric.…”

Section: Cointegration Approachsupporting

confidence: 57%

“…Rad et al . () provide the first large‐scale empirical application of the cointegration approach on U.S. CRSP data from 1962 until 2014, following GGR and Vidyamurthy (). The spread

ε_{i j, t}

between two stocks can be defined as

ε_{i j, t} = P_{i, t} + γ P_{j, t}

with

P_{i}

and

P_{j}

denoting the I (1)‐nonstationary price processes of stocks i and j .…”

Section: Cointegration Approachmentioning

confidence: 99%

“…(), and Rad et al . () develop the level‐based copula method. We briefly discuss the approach of Rad et al .…”

mentioning

confidence: 99%

See 2 more Smart Citations

Statistical Arbitrage Pairs Trading Strategies: Review and Outlook

Krauß

2016

Journal of Economic Surveys

160

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This survey reviews the growing literature on pairs trading frameworks, i.e., relative-value arbitrage strategies involving two or more securities. The available research is categorized into five groups: The distance approach uses nonparametric distance metrics to identify pairs trading opportunities. The cointegration approach relies on formal cointegration testing to unveil stationary spread time series. The time series approach focuses on finding optimal trading rules for mean-reverting spreads. The stochastic control approach aims at identifying optimal portfolio holdings in the legs of a pairs trade relative to other available securities. The category "other approaches" contains further relevant pairs trading frameworks with only a limited set of supporting literature. Drawing from this large set of research consisting of more than 90 papers, an in-depth assessment of each approach is performed, ultimately revealing strengths and weaknesses relevant for further research and for implementation. Terms of use: Documents in

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Section: Cointegration Approachsupporting

confidence: 57%

“…Rad et al . () provide the first large‐scale empirical application of the cointegration approach on U.S. CRSP data from 1962 until 2014, following GGR and Vidyamurthy (). The spread

ε_{i j, t}

between two stocks can be defined as

ε_{i j, t} = P_{i, t} + γ P_{j, t}

with

P_{i}

and

P_{j}

denoting the I (1)‐nonstationary price processes of stocks i and j .…”

Section: Cointegration Approachmentioning

confidence: 99%

See 1 more Smart Citation

Statistical Arbitrage Pairs Trading Strategies: Review and Outlook

Krauß

2016

Journal of Economic Surveys

160

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“…Xie, Liew, Wu, and Zou () find that the copula method is superior to distance method by investigating 89 U.S. stocks in the utility industry with a sample from 2003 to 2012. Rad, Low, and Faff () investigate the performance of the distance method, cointegration method, and copula method on the U.S. stock market from 1962 to 2014 and find that all three methods show significant profitability; however, the distance method outperforms the other methods slightly after adjusting for transaction costs.…”

Section: Introductionmentioning

confidence: 99%

Pairs trading across Mainland China and Hong Kong stock markets

Zhang

Urquhart

2018

Int. J Fin Econ

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Motivated by the rationale that market inefficiency arises from a combination of less than fully rational demand and limits to arbitrage, this paper investigates the profitability of pairs trading across Mainland China and Hong Kong on highly liquid large‐cap and midcap stocks from January 1996 to July 2017. We have three main findings. First, we find that pairs trading constrained within each market generates no significant abnormal returns. However, if investors can trade across Mainland China and Hong Kong, pairs trading is profitable after adjusting for risk and transaction costs, where the annualized abnormal return is 9% over the full sample. Second, by using a rolling‐window regression, we find that the profitability of the strategy is time‐varying. The bootstrap simulations suggest that the decline in profitability of the strategy since 2012 is due to random chance rather than poor ability of identifying mispriced stocks. However, the vast majority of profitable periods reflect the strategy's ability to choose profitable stocks rather than random chance. Third, the profitability of the strategy is somewhat sensitive to market conditions, most notably, the strategy is more profitable during longer term market turbulence. Overall, our empirical findings are consistent with the Adaptive Market Hypothesis in that the integration of financial markets and market conditions determine the level of market efficiency.

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“…Such computation means that one monetary unit is the gross exposure. Rad et al (2016) also consider one monetary unit as the total value of long and short positions. However, Karvinen (2012) and Augustine (2014) argue that the gross exposition should only consider both long and short exposures with one monetary unit each, which amounts for a total of two monetary units.…”

Section: Returns Calculationmentioning

confidence: 99%

Pairs Trading Strategy and Idiosyncratic Risk. Evidence in Spain and Europe.

2016

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(max 100 words)Pairs trading strategy's return depends on the divergence/convergence movements of a selected pair of stocks' prices. However, if the stable long term relationship of the stocks changes, price will not converge and the trade opened after divergence will close with losses. We propose a new model that, including companies' fundamental variables that measure idiosyncratic factors, anticipates the changes in this relationship and rejects those trades triggered by a divergence produced by fundamental changes in one of the companies. The model is tested on European stocks and the results obtained outperform those of the base distance model.

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The profitability of pairs trading strategies: distance, cointegration and copula methods

Cited by 110 publications

References 34 publications

Statistical Arbitrage Pairs Trading Strategies: Review and Outlook

Statistical Arbitrage Pairs Trading Strategies: Review and Outlook

Pairs trading across Mainland China and Hong Kong stock markets

Pairs Trading Strategy and Idiosyncratic Risk. Evidence in Spain and Europe.

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