Algorithmic Trading of Co-Integrated Assets

17 Pages Posted: 1 Aug 2015 Last revised: 24 May 2016

See all articles by Álvaro Cartea

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sebastian Jaimungal

University of Toronto - Department of Statistics

Date Written: August 19, 2015

Abstract

We assume that the drift in the returns of asset prices consists of an idiosyncratic component and a common component given by a co-integration factor. We analyze the optimal investment strategy for an agent who maximizes expected utility of wealth by dynamically trading in these assets. The optimal solution is constructed explicitly in closed-form and is shown to be affine in the co-integration factor. We calibrate the model to three assets traded on the Nasdaq exchange (Google, Facebook, and Amazon) and employ simulations to showcase the strategy's performance.

Keywords: Pairs trading, algorithmic trading, high-frequency trading, co-integration, short-term alpha, stochastic control

JEL Classification: C61, C32, G11, G12

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian, Algorithmic Trading of Co-Integrated Assets (August 19, 2015). International Journal of Theoretical and Applied Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2637883 or http://dx.doi.org/10.2139/ssrn.2637883

Álvaro Cartea

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Sebastian Jaimungal (Contact Author)

University of Toronto - Department of Statistics ( email )

100 St. George St.
Toronto, Ontario M5S 3G3
Canada

HOME PAGE: http://www.utstat.utoronto.ca/sjaimung

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