Pre-selection in Cointegration-based Pairs Trading

31 Pages Posted: 30 Jun 2020 Last revised: 11 Mar 2021

See all articles by Marianna Brunetti

Marianna Brunetti

Dept. Economics and Finance, University of Rome Tor Vergata; CEFIN

Roberta De Luca

Bank of Italy

Date Written: June 24, 2020

Abstract

This paper compares the final profitability of a cointegration-based pairs trading strategy when pairs of stocks are pre-selected using seven different measures. Pre-selection matters, since the excess returns remarkably vary, in terms of both average and variability, depending on the metrics used. Differences in profitability by pre-selection metrics are retrieved even after considering commissions and cut rules, market impact, and a stricter definition of the Spread reversion to the equilibrium. Besides, the profitability of the pairs trading strategy is also found heterogeneous across the different pre-selection metrics considered in terms of exposure to the traditional risk-factors.

Keywords: pairs trading, pre-selection, cointegration, profitability

JEL Classification: G10, G12, C44, C55

Suggested Citation

Brunetti, Marianna and De Luca, Roberta, Pre-selection in Cointegration-based Pairs Trading (June 24, 2020). CEIS Working Paper No. 500, Available at SSRN: https://ssrn.com/abstract=3634797 or http://dx.doi.org/10.2139/ssrn.3634797

Marianna Brunetti (Contact Author)

Dept. Economics and Finance, University of Rome Tor Vergata ( email )

Via Columbia, 2
Rome, Lazio 00133
Italy

HOME PAGE: http://economia.uniroma2.it/en/def/faculty/178/brunetti-marianna

CEFIN ( email )

via Berengario 51
Modena, modena I-41100
Italy

Roberta De Luca

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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