Pairs Trading in the Land Down Under

Abstract

Pairs trading is a market neutral investment strategy that attracts attention of academics and practitioners. Despite that, very little testing on the real market data has been published. This research considers three the most cited methods of pairs trading, two of them had never been tested on the real market data. Clear trading rules have been defined for all methods and their performance has been empirically assessed using the daily data covering 12 years history of the Australian stock exchange.

All three methods demonstrate statistically significant excess returns from 5% to 12% per year. However, after accounting for the transaction costs, two methods became unprofitable, and one earned minimal profit. These results demonstrate limited practical value of these strategies on the Australian stock market in their current form, suggesting the need for substantial improvements.

Keywords: pairs trading, spread process, cointegration

JEL Classification: G10, G12, C52, C14