Optimal dynamic pairs trading of futures under a two-factor mean-reverting model

Tim Leung and Raphael Yan ()
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Raphael Yan: #x2020;Department of Mathematics and Statistics, McMaster University, 1280 Main Street West, Hamilton, Ontario L8S 4K1, Canada

International Journal of Financial Engineering (IJFE), 2018, vol. 05, issue 03, 1-23

Abstract: We study the problem of dynamically trading a pair of futures contracts. We consider a two-factor mean-reverting model, where the spot price tends to evolve around its stochastic equilibrium that is also mean-reverting. We derive the futures price dynamics and determine the optimal futures trading strategy by solving a utility maximization problem. By analyzing the associated Hamilton–Jacobi–Bellman equation, we solve the utility maximization explicitly and provide the optimal trading strategies in closed form. Our strategies are applied to volatility (VIX) futures trading, and illustrated in a series of numerical examples.

Keywords: Dynamic trading; futures portfolio; mean-reverting model; utility maximization (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (10)

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DOI: 10.1142/S2424786318500275

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