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Pairs Trading: Performance of a Relative Value Arbitrage RuleEvan GatevSimon Fraser University William N. GoetzmannYale School of Management - International Center for Finance; National Bureau of Economic Research (NBER) K. Geert RouwenhorstYale School of Management - International Center for Finance February 2006 Yale ICF Working Paper No. 08-03 Abstract: We test a Wall Street investment strategy, pairs trading, with daily data over 1962-2002. Stocks are matched into pairs with minimum distance between normalized historical prices. A simple trading rule yields average annualized excess returns of up to 11 percent for selffinancing portfolios of pairs. The profits typically exceed conservative transaction costs estimates. Bootstrap results suggest that the pairs effect differs from previously-documented reversal profits. Robustness of the excess returns indicates that pairs trading profits from temporary mis-pricing of close substitutes. We link the profitability to the presence of a common factor in the returns, different from conventional risk measures.
Number of Pages in PDF File: 47 JEL Classification: G1 working papers seriesDate posted: December 28, 1998 ; Last revised: January 24, 2008Suggested CitationContact Information
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