Profitability of Pairs Trading Strategy In and Illiquid Market with Multiple Share Classes
Journal of International Financial Markets, Institutions and Money, 2012, Vol. 22, No. 5, 1188-1201.
26 Pages Posted: 21 Dec 2010 Last revised: 5 Jun 2013
Date Written: May 31, 2012
Abstract
We investigate the practical issues of implementing the self-financing pairs portfolio trading strategy presented by Gatev et al. (2006). We also provide new evidence on the profitability of pairs trading under different weighting structures and trade initiation conditions. Using data from the Finnish stock market over the period 1987–2008, we find pairs trading to be profitable even after allowing for a one day delay in the trade initiation after the signal. On average, the annualized return can be as high as 12.5%, though requiring trading on days a pair is traded lowers the return approximately by three percentage points. On the other hand, lowering the threshold for opening a pair is found to increase returns even after accounting for trading costs, indicating that there might be a more optimal trade initiation threshold available than that presented in earlier literature. The profits are not related to market risk. Pairs trading strategy is found to produce positive alpha during the sample period.
Keywords: Pairs, Trading Strategy, Statistical Arbitrage, Short-Selling, Finland, Helsinki Stock Exchange, NASDAQ, OMXH
JEL Classification: G10, G11
Suggested Citation: Suggested Citation
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