On the Determinants of Pairs Trading Profitability
44 Pages Posted: 6 Jan 2015
Date Written: December 22, 2014
We perform a large-scale empirical analysis of pairs trading, a popular relative-value arbitrage approach. We start with a cross-country study of 34 international stock markets and uncover that abnormal returns are a persistent phenomenon. We then construct a comprehensive U.S. data set to explore the sources behind the puzzling profitability in more depth. Our findings indicate that the type of news leading to pair divergence, the dynamics of investor attention as well as the dynamics of limits to arbitrage are important drivers of the strategy's time-varying performance.
Keywords: Pairs trading, relative-value arbitrage, return predictability, international stock markets, limited attention, limits to arbitrage
JEL Classification: G12, G14
Suggested Citation: Suggested Citation