Dynamic Pairs Trading Using the Stochastic Control Approach
affiliation not provided to SSRN
NYU Poly- Department of Finance and Risk Engineering
March 1, 2012
NYU Poly Research Paper Forthcoming
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: C61working papers series
Date posted: March 9, 2012
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