Mixed Copula Pairs Trading Strategy on the S&P 500

31 Pages Posted: 22 Nov 2017 Last revised: 24 Feb 2019

See all articles by Fernando B. Sabino da Silva

Fernando B. Sabino da Silva

Federal University of Rio Grande do Sul (UFRGS) - Statistics Department

Flávio Ziegelman

Flávio Ziegemann

João Caldeira

Universidade Federal do Rio Grande do Sul (UFRGS)

Date Written: November 14, 2017

Abstract

We propose an alternative investment strategy for pairs trading using Archimedean copulas in order to cover a wider range of tail dependence patterns and apply it to the S&P 500 stocks from 1990 to 2015. Empirical results show that our mixed copula approach generates higher average and risk adjusted excess returns and lower drawdown risk than the traditional distance method under different weighting structures when we control for trading costs. Particularly, the mixed copula and distance methods show a mean annualized value-weighted excess returns after costs on committed capital of 3.68% and 2.30% for top 5 pairs, with annual Sharpe ratios of 0.58 and 0.28, respectively. In addition, the mixed copula method shows a higher probability of yielding positive returns than the distance approach in different scenarios. The high returns can only partially be explained by common sources of systematic risk. The proposed mixture copulas have been found to be a superior fitting model over different market states, especially during subperiods of a stronger joint tail dependence.

Keywords: Pairs Trading, Copula, Distance Long-Short, Quantitative Strategies, S&P 500, Statistical Arbitrage.

JEL Classification: G11, G12, G14

Suggested Citation

B. Sabino da Silva, Fernando and Ziegelmann, Flávio and Caldeira, João, Mixed Copula Pairs Trading Strategy on the S&P 500 (November 14, 2017). Available at SSRN: https://ssrn.com/abstract=3070950 or http://dx.doi.org/10.2139/ssrn.3070950

Fernando B. Sabino da Silva (Contact Author)

Federal University of Rio Grande do Sul (UFRGS) - Statistics Department ( email )

Bento Goncalves, 9500, Ave
Porto Alegre, RS 91509-900
Brazil

Flávio Ziegelmann

Flávio Ziegemann ( email )

Rua Washington Luiz, 855. Centro
Porto Alegre - RS, 90010-460
Brazil

João Caldeira

Universidade Federal do Rio Grande do Sul (UFRGS) ( email )

Av. Carlos Gomes 1111
Porto Alegre, Rio Grande do Sul 90480-004
Brazil

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