Optimal Liquidation of a Pairs Trade

Erik Ekström (), Carl Lindberg () and Johan Tysk ()
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Erik Ekström: Uppsala University, Department of Mathematics
Carl Lindberg: Chalmers University of Technology, Mathematical Sciences
Johan Tysk: Uppsala University, Department of Mathematics

Chapter Chapter 9 in Advanced Mathematical Methods for Finance, 2011, pp 247-255 from Springer

Abstract: Abstract Pairs trading is a common strategy used by hedge funds. When the spread between two highly correlated assets is observed to deviate from historical observations, a long position is taken in the underpriced asset, and a short position in the overpriced one. If the spread narrows, both positions are closed, thus generating a profit. We study when to optimally liquidate a pairs trading strategy when the difference between the two assets is modeled by an Ornstein–Uhlenbeck process. We also provide a sensitivity analysis in the model parameters.

Keywords: Pairs trading; Optimal stopping theory; Ornstein–Uhlenbeck process; 91G10; 60G40 (search for similar items in EconPapers)
Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-642-18412-3_9

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DOI: 10.1007/978-3-642-18412-3_9

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