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When Does Pairs Trading Outperform Cross-Sectional Momentum?

Author

Listed:
  • Oh Kang Kwon

    (Discipline of Finance, Codrington Building (H69), The University of Sydney, Sydney, NSW 2006, Australia)

  • Stephen Satchell

    (Discipline of Finance, Codrington Building (H69), The University of Sydney, Sydney, NSW 2006, Australia
    Trinity College, University of Cambridge, Cambridge CB2 1TQ, UK)

Abstract

In this paper, we analyze the relative performances of pairs trading and cross-sectional momentum (CSM) strategies by comparing their expected returns. It is shown that the Sharpe ratio and the autocorrelation in the spread between the asset returns are the key factors in determining the relative performances of the two strategies, and an analytic expression for the condition under which one strategy outperforms the other is obtained in terms of these factors. It is also shown that the pairs trading strategy outperforms the CSM strategy in the majority of practically relevant situations.

Suggested Citation

  • Oh Kang Kwon & Stephen Satchell, 2022. "When Does Pairs Trading Outperform Cross-Sectional Momentum?," JRFM, MDPI, vol. 15(11), pages 1-7, November.
    • Handle: RePEc:gam:jjrfmx:v:15:y:2022:i:11:p:512-:d:963728
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    References listed on IDEAS

    as
    1. Oh Kang Kwon & Stephen Satchell, 2020. "The Distribution of Cross Sectional Momentum Returns When Underlying Asset Returns Are Student’s t Distributed," JRFM, MDPI, vol. 13(2), pages 1-19, February.
    2. Kwon, Oh Kang & Satchell, Stephen, 2018. "The distribution of cross sectional momentum returns," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 225-241.
    Full references (including those not matched with items on IDEAS)

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