A single-stage approach for cointegration-based pairs trading

K.F. LAW, Wai Keung LI, Philip L.H. YU

Research output: Contribution to journalArticle

Abstract

Pairs trading can be regarded as conditional mean reversion strategies. The conditions are usually imposed in two stages: Identification of pairs’ relationship and the opening (and closing) mechanism sequentially as a ‘pass or fail’ test. Nevertheless, as cointegration relationship is often not a ‘yes or no’ question but a ‘strong or weak’ one, dichotomizing the relationship through screening may not be optimal. This research presents a new single-stage approach to pairs trading based on a single ‘power statistic’. Its superiority in attaining better risk-to-reward ratios is demonstrated empirically in a large scale backtest study.1 Copyright © 2017 Elsevier Inc. All rights reserved.
Original languageEnglish
Pages (from-to)177-184
JournalFinance Research Letters
Volume26
Early online dateDec 2017
DOIs
Publication statusPublished - Sep 2018

Citation

Law, K. F., Li, W. K., & Yu, P. L. H. (2018). A single-stage approach for cointegration-based pairs trading. Finance Research Letters, 26, 177-184. doi: 10.1016/j.frl.2017.12.011

Keywords

  • Cointegration
  • Pairs trading
  • Power statistic
  • Risk control
  • Return maximization

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