Statistical Arbitrage and Robust Tests for Cointegration

42 Pages Posted: 1 Oct 2012

See all articles by Thomas A. Hanson

Thomas A. Hanson

Butler University - Lacy School of Business

Joshua Hall

Kent State University - College of Business Administration

Date Written: September 30, 2012

Abstract

One application of cointegration tests is screening candidate stocks for the investment strategy known as statistical arbitrage. This paper develops two robust tests for cointegration by using rank-based and least absolute deviation regression to modify the seminal Engle-Granger test. Critical values are generated and power calculated for various error distributions. Finally, the tests are utilized in a simple pairs trading strategy and backtested on daily data from 2001 to 2010. The rank-based cointegration test has superior qualities in that context, suggesting one application of this new statistical test.

Keywords: Statistical arbitrage, pairs trading, cointegration, robust statistics, rank-based statistics, weighted Wilcoxon regression, least absolute deviation

JEL Classification: G19

Suggested Citation

Hanson, Thomas A. and Hall, Joshua, Statistical Arbitrage and Robust Tests for Cointegration (September 30, 2012). Midwest Finance Association 2013 Annual Meeting Paper, Available at SSRN: https://ssrn.com/abstract=2154735 or http://dx.doi.org/10.2139/ssrn.2154735

Thomas A. Hanson (Contact Author)

Butler University - Lacy School of Business ( email )

4600 Sunset Avenue
Indianapolis, IN 46208
United States

Joshua Hall

Kent State University - College of Business Administration ( email )

P.O. Box 5190
Kent, OH 44242-0001
United States

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