Supercointegrated

51 Pages Posted: 21 Jul 2017 Last revised: 27 Nov 2017

See all articles by Isabel Figuerola-Ferretti

Isabel Figuerola-Ferretti

Comillas Pontifical University

Pedro Serrano

University Carlos III of Madrid - Department of Business Administration

Tao Tang

Jinan University

Antoni Vaello-Sebastià

University of the Balearic Islands

Date Written: July 19, 2017

Abstract

This paper uses S&P100 data to examine the performance of pairs trading portfolios that are sorted by the significance level of cointegration between their constituents. We find that portfolios that are formed with highly cointegrated pairs, named as "supercointegrated", yield the best performance reflecting a positive relationship between the level of cointegration and pairs trading profitability. The supercointegrated portfolio also shows superior out-of-sample performance to the simple buy-and-hold investments on the market portfolio in terms of Sharpe ratio. We link the time-varying risk of the pairs trading strategy to aggregated market volatility. Moreover we report a positive risk-return relationship between the strategy and market volatility, which is enhanced during the bear market. Our results remain valid when applying the strategy to European index data.

Keywords: Supercointegrated pairs; Pairs trading; Risk-return relationship

JEL Classification: G1; G2; E4; C5

Suggested Citation

Figuerola-Ferretti, Isabel and Serrano, Pedro and Tang, Tao and Vaello-Sebastià, Antoni, Supercointegrated (July 19, 2017). Available at SSRN: https://ssrn.com/abstract=3005358 or http://dx.doi.org/10.2139/ssrn.3005358

Isabel Figuerola-Ferretti

Comillas Pontifical University ( email )

Alberto Aguilera 21
Madrid, Madrid 28015
Spain

Pedro Serrano

University Carlos III of Madrid - Department of Business Administration ( email )

C/ Madrid, 126
Getafe, Madrid 28903
Spain
+34916248926 (Phone)

Tao Tang (Contact Author)

Jinan University ( email )

Huang Pu Da Dao Xi 601, Tian He District
Guangzhou, Guangdong 510632
China

Antoni Vaello-Sebastià

University of the Balearic Islands ( email )

Crtra. Valldemossa, km 7.5
Ed. Ramon Llull
Palma de Mallorca, Illles Balears 07122
Spain
971172024 (Phone)

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