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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.

Number of Pages in PDF File: 47

JEL Classification: G1

working papers series


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

Suggested Citation

Gatev, Evan and 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 http://dx.doi.org/10.2139/ssrn.141615

Contact Information

Evan Gatev
Simon Fraser University ( email )
Burnaby, British Columbia V5A 1S6
Canada
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
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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