Pairs Trading: Performance of a Relative Value Arbitrage Rule

35 Pages Posted: 20 Sep 2000  

Evan G. Galev

Yale School of Management

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

Date Written: March 1999

Abstract

We test a Wall Street investment strategy known as pairs trading' with daily data over the period 1962 through 1997. Stocks are matched into pairs according to minimum distance in historical normalized price space. We test the profitability of several trading rules with six-month trading periods over the 1962-1997 period, and find average annualized excess returns of up to 12 percent for a number of self-financing portfolios of top pairs. Part of these profits may be due to market microstructure effects. Nevertheless, our historical trading profits exceed a conservative estimate of transaction costs through most of the period. We bootstrap random pairs in order to distinguish pairs trading from pure mean-reversion strategies. The bootstrap results suggest that the pairs' effect differs from previously documented mean reversion profits.

Suggested Citation

Galev, Evan G. and Goetzmann, William N. and Rouwenhorst, K. Geert, Pairs Trading: Performance of a Relative Value Arbitrage Rule (March 1999). NBER Working Paper No. w7032. Available at SSRN: https://ssrn.com/abstract=227415

Evan G. Galev

Yale School of Management

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William N. Goetzmann (Contact Author)

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

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National Bureau of Economic Research (NBER)

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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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