Pairs Trading and Spread Persistence in the European Stock Market

Forthcoming, Journal of Futures Markets

Posted: 11 Nov 2017 Last revised: 7 May 2018

Date Written: April 30, 2018

Abstract

In this paper we adapt the demand and supply framework introduced by Figuerola-Ferretti and Gonzalo (Journal of Econometrics 2010) to illustrate the dynamics of pairs trading. We underline the process by which a finite elasticity of demand for spread trading determines the speed of mean reversion and pairs trading profitability. A persistence-dependent trading trigger is introduced accordingly. Applied to STOXX Europe 600 traded equities our strategy exploits price leadership for portfolio replication purposes and delivers Sharpe ratios that outperform the benchmark rules used in the literature. Portfolio performance and mean reversion are enhanced after firm fundamental factor restrictions are imposed.

Keywords: pairs trading, cointegration, price discovery, error persistence, trading trigger

JEL Classification: C58, G11, G12, G14

Suggested Citation

Figuerola-Ferretti, Isabel and Paraskevopoulos, Ioannis and Tang, Tao, Pairs Trading and Spread Persistence in the European Stock Market (April 30, 2018). Forthcoming, Journal of Futures Markets, Available at SSRN: https://ssrn.com/abstract=3067442 or http://dx.doi.org/10.2139/ssrn.3067442

Isabel Figuerola-Ferretti

Comillas Pontifical University ( email )

Alberto Aguilera 21
Madrid, Madrid 28015
Spain

Ioannis Paraskevopoulos

Bankia ( email )

Torre Caja Madrid
P. de la Castellana, 189
Madrid, 28046
Spain
+34618969259 (Phone)

Tao Tang (Contact Author)

Jinan University ( email )

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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
612
PlumX Metrics