Dynamic pairs trading using the stochastic control approach

Agnès Tourin and Raphael Yan

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 10, 1972-1981

Abstract: We propose a model for analyzing dynamic pairs trading strategies using the stochastic control approach. The model is explored in an optimal portfolio setting, where the portfolio consists of a bank account and two co-integrated stocks and the objective is to maximize for a fixed time horizon, the expected terminal utility of wealth. For the exponential utility function, we reduce the problem to a linear parabolic partial differential equation which can be solved in closed form. In particular, we exhibit the optimal positions in the two stocks.

Keywords: Optimal stochastic control; Pairs trading; Co-integration; Hamilton Jacobi Bellman equation; Merton problem (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (41)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:10:p:1972-1981

DOI: 10.1016/j.jedc.2013.05.010

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