Ultra-High-Frequency Pairs Trading in Gold ETFs

31 Pages Posted: 7 Jun 2017

See all articles by Thong Dao

Thong Dao

University of Southampton - Business School

Frank McGroarty

University of Southampton - Southampton Business School

Andrew Urquhart

ICMA Centre, Henley Business School

Date Written: June 6, 2017

Abstract

Based on a large dataset of gold ETFs, we find arbitrage opportunities in the gold ETF market which can be exploited by high-frequency traders. To our knowledge, this is the first paper to study pairs trading of gold ETFs using tick data. Able to execute their orders with minimal delay and take advantage of potentially short-lived opportunities, high-frequency traders can make an excess return of 2.1% p.a. after including transaction costs. Consistent with Grossman and Stiglitz (1976) and Grossman and Stiglitz (1980), this profitability may be compensation for arbitrage efforts and incentivise arbitrageurs to eliminate mispricing. We also explain why the trade exit rule of full convergence used in previous studies may not be optimal and propose a rule based on partial convergence which outperforms the standard full-convergence rule. Specifically, changing the exit rule from full convergence to partial convergence can increase pairs trading returns to 3.38% p.a. and also enhance the risk-adjusted performance based on different risk adjustment methods. More importantly, the outperformance of partial convergence is consistent in both the whole sample and the sub-samples with the optimal convergence target being around 40%. Therefore, partial convergence enables better exploitation of arbitrage opportunities than full convergence. Finally, the pairs trading returns exceed compensation for risks, which suggests that the gold ETF market may be inefficient at ultra-high frequency.

Keywords: pairs trading, statistical arbitrage, high frequency, gold ETFs

Suggested Citation

Dao, Thong and McGroarty, Frank and Urquhart, Andrew, Ultra-High-Frequency Pairs Trading in Gold ETFs (June 6, 2017). Available at SSRN: https://ssrn.com/abstract=2981717 or http://dx.doi.org/10.2139/ssrn.2981717

Thong Dao

University of Southampton - Business School ( email )

SO17 1TR
United Kingdom

Frank McGroarty

University of Southampton - Southampton Business School ( email )

Southampton, SO17 1BJ
United Kingdom

Andrew Urquhart (Contact Author)

ICMA Centre, Henley Business School ( email )

University of Reading
Whiteknights
Reading, Berkshire RG6 6BA
United Kingdom

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