Dynamic Pairs Trading Using the Stochastic Control Approach

Yan, Raphael; Tourin, Agnes

doi:10.2139/ssrn.2014271

Abstract

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Dynamic Pairs Trading Using the Stochastic Control Approach

NYU Poly- Department of Finance and Risk Engineering

March 1, 2012

NYU Poly Research Paper Forthcoming

Abstract:
We propose a model for analyzing dynamic pairs trading strategies using the stochastic control approach. The model is explored in an optimal portfolio setting, where the portfolio consists of a bank account and two co-integrated stocks and the objective is to maximize for a fixed time horizon, the expected terminal utility of wealth. For the exponential utility function, we reduce the problem to a linear parabolic Partial Differential Equation which can be solved in closed form. In particular, we exhibit the optimal positions in the two stocks.

Number of Pages in PDF File: 20

Keywords: Optimal Stochastic Control, Pairs trading, Co-integration, Hamilton-Jacobi-Bellman equation

JEL Classification: C61

working papers series

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Date posted: March 9, 2012

Suggested Citation

Yan, Raphael and Tourin, Agnes, Dynamic Pairs Trading Using the Stochastic Control Approach (March 1, 2012). NYU Poly Research Paper Forthcoming. Available at SSRN: http://ssrn.com/abstract=2014271 or http://dx.doi.org/10.2139/ssrn.2014271

Contact Information

Raphael Yan (Contact Author) affiliation not provided to SSRN ( email )
Agnes Tourin NYU Poly- Department of Finance and Risk Engineering ( email ) Brooklyn, NY 11201 United States

Abstract

Dynamic Pairs Trading Using the Stochastic Control Approach

Raphael Yan

Agnes Tourin

Date posted: March 9, 2012

Suggested Citation

Contact Information

Raphael Yan (Contact Author)

Agnes Tourin