Optimal pairs trading strategies in a cointegration framework

Zhe Huang and Franck Martin
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Zhe Huang: Université de Rennes 1, CREM UMR CNRS 6211, France

Economics Working Paper Archive (University of Rennes & University of Caen) from Center for Research in Economics and Management (CREM), University of Rennes, University of Caen and CNRS

Abstract: Statistical arbitrage is based on pairs trading of mean-reverting returns. We used cointegration approach and ECM-DCC-GARCH to construct 98 pairs of 152 stocks of 3 currencies. Stocks trading is done by Contract for Difference, a financial derivative product which facilitates short selling and provides a leverage up to 25 times. To measure the performance of a leveraged strategy, we introduced the profit factor which is the annualized return rate per unit risk. And the historical risk is measured by maximum drawdown. We compared three main strategies: percentage, standard deviation of cointegration long term residuals and Bollinger Bands (dynamic standard deviation), with and without double confirmation of short term standard deviation modeled by ECM-DCC-GARCH. Each of the three main strategies is optimized by two optimizers: absolute profit and profit factor. The optimization period goes from 2012-01-01 to 2014-12-31, and validation period is from 2015-01-01 to 2016-06-01. Our results showed that the USD Bollinger Bands strategy without double confirmation and optimized by profit factor, outperformed other strategies and provided the highest annualized return rate per unit risk.

Keywords: Pairs trading; Cointegration; GARCH Model; Bollinger bands; Back-testing; Market efficiency (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2017-07
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Citations: View citations in EconPapers (1)

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Working Paper: Optimal pairs trading strategies in a cointegration framework (2017)
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