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Profitability Of A Simple Pairs Trading Strategy: Recent Evidences From A Global Context

Author

Listed:
  • JIA MIAO

    (School of Accounting, Finance and Informatics, Kingston Business School, Kingston Hill Campus, Kingston University, London KT2 7LB, UK)

  • JASON LAWS

    (#x2020;Department of Economics, Finance and Accounting, Liverpool Management School, Chatham Building, Chatham Street, University of Liverpool, L69 7ZH, UK)

Abstract

Pairs trading strategy is a popular investment strategy, where traders long one stock and short the other stock. The trading profits are expected to be “immune” to any market conditions: being uptrend, downtrend, or sideways, instead the performance is determined by the relative performance of the pair. Following Gatev et al. [(1999) Pairs Trading: Performance of a Relative-Value Arbitrage Rule. Working Paper, Yale School of Management; (2006) Pairs trading: Performance of a relative-value arbitrage rule, The Review of Financial Study, 19, 797–827] and Do & Faff [(2010) Does simple pairs trading still work? Financial Analyst Journal, 66, 1–12], we examine whether the simple pairs trading rule is also profitable in markets outside of the US. We also examine whether the trading rule performs consistently during bull and bear markets, including the recent period of market turbulence. Our results show that in most countries, the strategy generates positive returns, without evidence of under performance during bear markets. Unlike prior research, we do not find that the trading profits diminish over recent years. The pairs trading strategy generates positive returns even after transaction costs. However, the returns deteriorate significantly at a higher level of transaction costs. It is also found that the correlation between the returns on our pairs trading portfolios and the returns on the corresponding stock market indexes is low, confirming its role as a diversifier to the traditional long only investments.

Suggested Citation

  • Jia Miao & Jason Laws, 2016. "Profitability Of A Simple Pairs Trading Strategy: Recent Evidences From A Global Context," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(04), pages 1-18, June.
    • Handle: RePEc:wsi:ijtafx:v:19:y:2016:i:04:n:s0219024916500230
    DOI: 10.1142/S0219024916500230
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    References listed on IDEAS

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    1. Broussard, John Paul & Vaihekoski, Mika, 2012. "Profitability of pairs trading strategy in an illiquid market with multiple share classes," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(5), pages 1188-1201.
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