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Stop-loss and leverage in optimal statistical arbitrage with an application to energy market

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  • Baviera, Roberto
  • Santagostino Baldi, Tommaso

Abstract

In this paper, we develop a statistical arbitrage trading strategy with two key elements in hi-frequency trading: stop-loss and leverage. We consider, as in Bertram (2009), a mean-reverting process for the security price with proportional transaction costs; we show how to introduce stop-loss and leverage in an optimal trading strategy.

Suggested Citation

  • Baviera, Roberto & Santagostino Baldi, Tommaso, 2019. "Stop-loss and leverage in optimal statistical arbitrage with an application to energy market," Energy Economics, Elsevier, vol. 79(C), pages 130-143.
    • Handle: RePEc:eee:eneeco:v:79:y:2019:i:c:p:130-143
    DOI: 10.1016/j.eneco.2018.03.024
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    References listed on IDEAS

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    1. Tang, Cheng Yong & Chen, Song Xi, 2009. "Parameter estimation and bias correction for diffusion processes," Journal of Econometrics, Elsevier, vol. 149(1), pages 65-81, April.
    2. Mark Cummins & Andrea Bucca, 2012. "Quantitative spread trading on crude oil and refined products markets," Quantitative Finance, Taylor & Francis Journals, vol. 12(12), pages 1857-1875, December.
    3. Fred Espen Benth & Jūratė Šaltytė Benth & Steen Koekebakker, 2008. "Stochastic Modeling of Electricity and Related Markets," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 6811, August.
    4. Jun Yu & Peter C. B. Phillips, 2001. "A Gaussian approach for continuous time models of the short-term interest rate," Econometrics Journal, Royal Economic Society, vol. 4(2), pages 1-3.
    5. Michael Taksar & Michael J. Klass & David Assaf, 1988. "A Diffusion Model for Optimal Portfolio Selection in the Presence of Brokerage Fees," Mathematics of Operations Research, INFORMS, vol. 13(2), pages 277-294, May.
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    7. Evan Gatev & William N. Goetzmann & K. Geert Rouwenhorst, 2006. "Pairs Trading: Performance of a Relative-Value Arbitrage Rule," The Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 797-827.
    8. Bertram, William K., 2009. "Optimal trading strategies for Itô diffusion processes," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(14), pages 2865-2873.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Mean-reversion trading; Stop-loss; First-Exit-Time;
    All these keywords.

    JEL classification:

    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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