A Pairs Trading Strategy Based on Mixed Copulas

29 Pages Posted: 22 Nov 2017 Last revised: 2 Mar 2022

See all articles by Fernando B. Sabino da Silva

Fernando B. Sabino da Silva

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

Flávio Ziegelman

Flávio Ziegemann

João Caldeira

Universidade Federal de Santa Catarina & CNPq

Date Written: November 14, 2017

Abstract

We propose an alternative pairs trading strategy based on computing a mispricing index in a novel way via a mixed copula model, or more specifically via an optimal linear combination of copulas. We evaluate the statistical and economic performances of our proposed approach by analyzing S&P 500 daily stock returns between 1990 and 2015. Empirical results are obtained not only from the full sample analysis but also from subperiods analyses. These subperiods are chosen in two different ways: i) fixed time length; and ii) bull/bear market dependent. The fixed time length analysis is able to capture possible dynamics changes over time whereas the bull/bear analysis makes it possible for one to have distinct pairs trading strategies depending on the market state. Our results suggest that two-component mixed copulas perform very well, especially during bear market times when it regards to mean returns.

Keywords: Pairs Trading, Copula, Distance, 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, A Pairs Trading Strategy Based on Mixed Copulas (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) - Economics Department ( email )

52 Joao Pessoa, Office: Econ 305
Porto Alegre, RS 90040-000
Brazil

Flávio Ziegelmann

Flávio Ziegemann ( email )

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

João Caldeira

Universidade Federal de Santa Catarina & CNPq ( email )

R. Eng. Agronômico Andrei Cristian Ferreira, s/n
Florianópolis, SC Rio Grande do Sul 90480-004
Brazil

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