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A good pair: alternative pairs-trading strategies

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  • R. Todd Smith

    (University of Alberta)

  • Xun Xu

    (Vestcor Investment Management Corporation)

Abstract

This paper studies alternative techniques for identifying stock pairs in a pairs-trading strategy over 1980–2014. We consider two main techniques: the distance approach and the cointegration approach. We also consider a range of parameterizations of the trading system design. Parameterization of the trading system matters for the profitability of pairs trading. We find that the cointegration approach, despite using an optimal in-sample parameterization, yields significant returns only in the 1980s. The distance approach performs better, producing significantly positive risk-adjusted returns in all sub-periods. However, when transaction costs are properly taken into account, the returns largely disappear in recent years.

Suggested Citation

  • R. Todd Smith & Xun Xu, 2017. "A good pair: alternative pairs-trading strategies," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 31(1), pages 1-26, February.
    • Handle: RePEc:kap:fmktpm:v:31:y:2017:i:1:d:10.1007_s11408-016-0280-x
    DOI: 10.1007/s11408-016-0280-x
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    References listed on IDEAS

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    Cited by:

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    2. Yen-Sheng Lee, 2022. "Representative Bias and Pairs Trade: Evidence From S&P 500 and Russell 2000 Indexes," SAGE Open, , vol. 12(3), pages 21582440221, August.

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    More about this item

    Keywords

    Stocks; Pairs trading; Investing; Arbitrage;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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