An Application of the Ornstein-Uhlenbeck Process to Pairs Trading

Jirat Suchato, Sean Wiryadi, Danran Chen, Ava Zhao and Michael Yue

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Abstract: We conduct a preliminary analysis of a pairs trading strategy using the Ornstein-Uhlenbeck (OU) process to model stock price spreads. We compare this approach to a naive pairs trading strategy that uses a rolling window to calculate mean and standard deviation parameters. Our findings suggest that the OU model captures signals and trends effectively but underperforms the naive model on a risk-return basis, likely due to non-stationary pairs and parameter tuning limitations.

Date: 2024-12
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