Pairs Trading: Performance of a Relative Value Arbitrage Rule

Evan G. Gatev, William Goetzmann and K. Rouwenhorst

No 7032, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We test a Wall Street investment strategy known as pairs trading' with daily data over the period 1962 through 1997. Stocks are matched into pairs according to minimum distance in historical normalized price space. We test the profitability of several trading rules with six-month trading periods over the 1962-1997 period, and find average annualized excess returns of up to 12 percent for a number of self-financing portfolios of top pairs. Part of these profits may be due to market microstructure effects. Nevertheless, our historical trading profits exceed a conservative estimate of transaction costs through most of the period. We bootstrap random pairs in order to distinguish pairs trading from pure mean-reversion strategies. The bootstrap results suggest that the pairs' effect differs from previously documented mean reversion profits.

Date: 1999-03
New Economics Papers: this item is included in nep-fin and nep-pbe
Note: AP
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Citations: View citations in EconPapers (24)

Published as Evan Gatev & William N. Goetzmann & K. Geert Rouwenhorst, 2006. "Pairs Trading: Performance of a Relative-Value Arbitrage Rule," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(3), pages 797-827.

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Journal Article: Pairs Trading: Performance of a Relative-Value Arbitrage Rule (2006)
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