Deep Learning Statistical Arbitrage
75 Pages Posted: 8 Jun 2021 Last revised: 11 Jan 2024
Date Written: March 15, 2019
Abstract
Statistical arbitrage exploits temporal price differences between similar assets. We develop a comprehensive conceptual framework for statistical arbitrage and a novel data driven solution. First, we construct arbitrage portfolios of similar assets as residual portfolios from conditional latent asset pricing factors. Second, we extract their time series signals with a powerful machine-learning time-series solution, a convolutional transformer. Lastly, we use these signals to form an optimal trading policy, that maximizes risk-adjusted returns under constraints. Our comprehensive empirical study on daily US equities shows a high compensation for arbitrageurs to enforce the law of one price. Our arbitrage strategies obtain consistently high out-of-sample mean returns and Sharpe ratios, and substantially outperform all benchmark approaches.
Keywords: statistical arbitrage, pairs trading, machine learning, deep learning, big data, stock returns, convolutional neural network, transformer, attention, factor model, market efficiency, investment
JEL Classification: C14, C38, C55, G12
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