A Regime-Switching Relative Value Arbitrage Rule

6 Pages Posted: 10 Aug 2008

See all articles by Michael Bock

Michael Bock

University of Graz

Roland Mestel

University of Graz

Date Written: August 9, 2008


The relative value arbitrage rule ("pairs trading") is a well-established speculative investment strategy on financial markets, dating back to the 1980s. Based on relative mispricing between a pair of stocks, pairs trading strategies create excess returns if the spread between two normally comoving stocks is away from its equilibrium path and is assumed to be mean reverting. To overcome the problem of detecting temporary in contrast to longer lasting deviations from spread equilibrium, this paper bridges the literature on Markov regime-switching and the scientific work on statistical arbitrage.

Keywords: statistical arbitrage, pairs trading, mean reversion, Markow regime switching,

JEL Classification: C53, G12

Suggested Citation

Bock, Michael and Mestel, Roland, A Regime-Switching Relative Value Arbitrage Rule (August 9, 2008). Available at SSRN: https://ssrn.com/abstract=1213802 or http://dx.doi.org/10.2139/ssrn.1213802

Michael Bock

University of Graz ( email )

Universitaetsstrasse 15 / FE
A-8010 Graz, 8010

Roland Mestel (Contact Author)

University of Graz ( email )

Institute of Banking and Finance
Universitaetsstrasse 15/F2
A-8010 Graz
+43 316 380 7304 (Phone)
+43 316 380 9580 (Fax)

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