Pairs Trading: Performance of a Relative-Value Arbitrage Rule

Posted: 29 Feb 2008

See all articles by Evan Gatev

Evan Gatev

Simon Fraser University

William N. Goetzmann

Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)

K. Geert Rouwenhorst

Yale School of Management - International Center for Finance

Multiple version iconThere are 2 versions of this paper

Date Written: 2006

Abstract

We test a Wall Street investment strategy, "pairs trading," with daily data over 1962-2002. Stocks are matched into pairs with minimum distance between normalized historical prices. A simple trading rule yields average annualized excess returns of up to 11% for self-financing portfolios of pairs. The profits typically exceed conservative transaction-cost estimates. Bootstrap results suggest that the "pairs" effect differs from previously documented reversal profits. Robustness of the excess returns indicates that pairs trading profits from temporary mispricing of close substitutes. We link the profitability to the presence of a common factor in the returns, different from conventional risk measures.

Suggested Citation

Gatev, Evan and Goetzmann, William N. and Rouwenhorst, K. Geert, Pairs Trading: Performance of a Relative-Value Arbitrage Rule ( 2006). The Review of Financial Studies, Vol. 19, Issue 3, pp. 797-827, 2006. Available at SSRN: https://ssrn.com/abstract=1095996 or http://dx.doi.org/10.1093/rfs/hhj020

Evan Gatev (Contact Author)

Simon Fraser University ( email )

Burnaby, British Columbia V5A 1S6
Canada

William N. Goetzmann

Yale School of Management - International Center for Finance ( email )

165 Whitney Ave.
P.O. Box 208200
New Haven, CT 06520-8200
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203-432-5950 (Phone)
203-436-9252 (Fax)

HOME PAGE: http://viking.som.yale.edu

National Bureau of Economic Research (NBER)

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K. Geert Rouwenhorst

Yale School of Management - International Center for Finance ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6046 (Phone)
203-432-8931 (Fax)

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