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.
CitationLaw, 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
- Pairs trading
- Power statistic
- Risk control
- Return maximization