Pairs Trading Strategy and Idiosyncratic Risk. Evidence in Spain and Europe.

37 Pages Posted: 11 Jul 2016

See all articles by Marisa Mazo

Marisa Mazo

Comillas Pontifical University

Maria Esther Vaquero Lafuente

Comillas Pontifical University - Department of Financial Management

Ricardo Gimeno

Banco de España

Date Written: July 11, 2016

Abstract

Pairs trading strategy’s return depends on the divergence/convergence movements of a selected pair of stocks’ prices. However, if the stable long term relationship of the stocks changes, price will not converge and the trade opened after divergence will close with losses. We propose a new model that, including companies’ fundamental variables that measure idiosyncratic factors, anticipates the changes in this relationship and rejects those trades triggered by a divergence produced by fundamental changes in one of the companies. The model is tested on European stocks and the results obtained outperform those of the base distance model.

Keywords: Pairs trading, stocks, idiosyncratic risk, EPS, BVPS

JEL Classification: G170, G120, G140

Suggested Citation

Mazo, Marisa and Vaquero Lafuente, Maria Esther and Gimeno, Ricardo, Pairs Trading Strategy and Idiosyncratic Risk. Evidence in Spain and Europe. (July 11, 2016). Available at SSRN: https://ssrn.com/abstract=2807956 or http://dx.doi.org/10.2139/ssrn.2807956

Marisa Mazo

Comillas Pontifical University ( email )

Alberto Aguilera 21
Madrid, Madrid 28015
Spain

Maria Esther Vaquero Lafuente (Contact Author)

Comillas Pontifical University - Department of Financial Management ( email )

United States

Ricardo Gimeno

Banco de España ( email )

Madrid 28014
Spain

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