When Does Pairs Trading Outperform Cross-Sectional Momentum?

Oh Kang Kwon () and Stephen Satchell
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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

JRFM, 2022, vol. 15, issue 11, 1-7

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.

Keywords: cross-sectional momentum; pairs trading; Sharpe ratio; spread autocorrelation (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2022
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