Profitability of Pairs Trading Strategy In and Illiquid Market with Multiple Share Classes

26 Pages Posted: 21 Dec 2010 Last revised: 5 Jun 2013

See all articles by John Paul Broussard

John Paul Broussard

University of Oklahoma; Rutgers University

Mika Vaihekoski

University of Turku, Turku School of Economics; University of Turku - Turku School of Economics

Date Written: May 31, 2012

Abstract

We investigate the practical issues of implementing the self-financing pairs portfolio trading strategy presented by Gatev et al. (2006). We also provide new evidence on the profitability of pairs trading under different weighting structures and trade initiation conditions. Using data from the Finnish stock market over the period 1987–2008, we find pairs trading to be profitable even after allowing for a one day delay in the trade initiation after the signal. On average, the annualized return can be as high as 12.5%, though requiring trading on days a pair is traded lowers the return approximately by three percentage points. On the other hand, lowering the threshold for opening a pair is found to increase returns even after accounting for trading costs, indicating that there might be a more optimal trade initiation threshold available than that presented in earlier literature. The profits are not related to market risk. Pairs trading strategy is found to produce positive alpha during the sample period.

Keywords: Pairs, Trading Strategy, Statistical Arbitrage, Short-Selling, Finland, Helsinki Stock Exchange, NASDAQ, OMXH

JEL Classification: G10, G11

Suggested Citation

Broussard, John Paul and Vaihekoski, Mika and Vaihekoski, Mika, Profitability of Pairs Trading Strategy In and Illiquid Market with Multiple Share Classes (May 31, 2012). Journal of International Financial Markets, Institutions and Money, 2012, Vol. 22, No. 5, 1188-1201., Available at SSRN: https://ssrn.com/abstract=1729182 or http://dx.doi.org/10.2139/ssrn.1729182

John Paul Broussard

University of Oklahoma ( email )

Norman, OK 73019
United States
4053255591 (Phone)

HOME PAGE: http://https://www.ou.edu/price/finance/faculty/john-paul-broussard

Rutgers University ( email )

Camden, NJ 08102
United States
+18562256647 (Phone)

Mika Vaihekoski (Contact Author)

University of Turku, Turku School of Economics ( email )

Turku School of Economics
Dep. of Accounting and Finance
University of Turku, 20014
Finland
+358 2 33351 (Phone)

HOME PAGE: http://users.utu.fi/moovai/

University of Turku - Turku School of Economics ( email )

Turku, 20014
Finland

HOME PAGE: http://users.utu.fi/moovai/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
719
Abstract Views
4,255
Rank
68,605
PlumX Metrics