Mean Reversion Based on Autocorrelation: A Comparison Using the S&P 100 Constituent Stocks and the 100 Most Liquid ETFs

Abstract

The motivation for this paper is to show that even a simple strategy based on conditional autocorrelation can give traders an edge.

Our simple mean reversion strategy takes the position in a pair consisting of Exchange traded funds (ETFs) or shares based on the normalized previous period's return and the actual conditional autocorrelation.

We conclude that ETFs are more suitable financial instrument for our strategy than stocks.

Yet, another finding is that the strategy is significantly improved when we use half-daily (open-close-open-...) sampling frequency as opposed to the daily one (close-close). Information ratios after accounting for transaction costs (TC) range between 1.4 and 2.8 for ETF pairs at half-daily sampling frequency.

Keywords: Mean reversion, ETFs, pairs trading, autocorrelation

JEL Classification: C00, C10, C50, G00, G11