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Pairs Trading: Performance of a Relative Value Arbitrage Rule

Evan Gatev
Simon Fraser University

William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)

K. Geert Rouwenhorst
Yale 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.

JEL Classifications: G1

Working Paper Series

Date posted: December 28, 1998 ; Last revised: January 24, 2008

Suggested Citation

Gatev, Evan, Goetzmann, William N. and Rouwenhorst, K. Geert, Pairs Trading: Performance of a Relative Value Arbitrage Rule (February 2006). Yale ICF Working Paper No. 08-03. Available at SSRN: http://ssrn.com/abstract=141615 or doi:10.2139/ssrn.141615


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Contact Information

William N. Goetzmann (Contact Author)
Yale School of Management - International Center for Finance ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-5950 (Phone)
203-432-8931 (Fax)
HOME PAGE: http://viking.som.yale.edu
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Evan Gatev
Simon Fraser University ( email )
Burnaby, British Columbia V5A 1S6
Canada
K. Geert Rouwenhorst
Yale School of Management - International Center for Finance ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6046 (Phone)
203-432-8931 (Fax)
HOME PAGE: http://som.yale.edu/~geert/

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