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Pairs Trading: Performance of a Relative Value Arbitrage Rule

47 Pages Posted: 28 Dec 1998 Last revised: 24 Jan 2008

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: February 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 percent for selffinancing portfolios of pairs. The profits typically exceed conservative transaction costs 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 mis-pricing of close substitutes. We link the profitability to the presence of a common factor in the returns, different from conventional risk measures.

JEL Classification: G1

Suggested Citation

Gatev, Evan and Goetzmann, William N. and Rouwenhorst, K. Geert, Pairs Trading: Performance of a Relative Value Arbitrage Rule (February 2006). Yale ICF Working Paper No. 08-03. Available at SSRN: https://ssrn.com/abstract=141615 or http://dx.doi.org/10.2139/ssrn.141615

Evan Gatev

Simon Fraser University ( email )

Burnaby, British Columbia V5A 1S6
Canada

William N. Goetzmann (Contact Author)

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

165 Whitney Ave.
P.O. Box 208200
New Haven, CT 06520-8200
United States
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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Cambridge, MA 02138
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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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