Selection of a Portfolio of Pairs Based on Cointegration: A Statistical Arbitrage Strategy

28 Pages Posted: 5 Jan 2013

See all articles by João Caldeira

João Caldeira

Universidade Federal do Rio Grande do Sul (UFRGS)

Guilherme V. Moura

Universidade Federal de Santa Catarina (UFSC) - Department of Economics

Date Written: January 4, 2013

Abstract

Statistical arbitrage strategies, such as pairs trading and its generalizations, rely on the construction of mean- reverting spreads with a certain degree of predictability. This paper applies cointegration tests to identify stocks to be used in pairs trading strategies. In addition to estimating long-term equilibrium and to model the resulting residuals, we select stock pairs to compose a pairs trading portfolio based on an indicator of profitability evaluated in-sample. The profitability of the strategy is assessed with data from the São Paulo stock exchange ranging from January 2005 to October 2012. Empirical analysis shows that the proposed strategy exhibit excess returns of 16.38% per year, Sharpe Ratio of 1.34 and low correlation with the market.

Keywords: statistical arbitrage, pairs trading, cointegration, market neutral strategy

JEL Classification: C53, E43, G17

Suggested Citation

Caldeira, João and Moura, Guilherme Valle, Selection of a Portfolio of Pairs Based on Cointegration: A Statistical Arbitrage Strategy (January 4, 2013). Available at SSRN: https://ssrn.com/abstract=2196391 or http://dx.doi.org/10.2139/ssrn.2196391

João Caldeira (Contact Author)

Universidade Federal do Rio Grande do Sul (UFRGS) ( email )

Av. Carlos Gomes 1111
Porto Alegre, Rio Grande do Sul 90480-004
Brazil

Guilherme Valle Moura

Universidade Federal de Santa Catarina (UFSC) - Department of Economics ( email )

PO Box 476
Florianopolis, SC 88010-970
Brazil

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