Optimal Pairs Trading strategy under Statistical Variability of the Spread Process

Subject Areas : Financial engineering

Fatemeh Azizzadeh ¹ , Nasrin Ebadi ²

1 - Financial mathematics group, financial sciences faculty, Kharazmi university' Tehran
2 - Master of Financial Mathematics, Faculty of Finance, Kharazmi University, Tehran, Iran

Received: 2017-05-31 Accepted : 2017-10-07 Published : 2017-12-22

Keywords: Pairs trading, Statistical arbitrage, Mean reversion model, Stochastic volatility, Ornstein-Uhlenbeck process,

Abstract :

The appropriate investment and decision making about taking of correct long and short position needs proved strategies. In this research, pairs trading have been studied and a new non-parametric approach proposed based on Renko and Kagi construction which are two Japanese charting indicators. The proposed approach exploits information about the variability of spread process and a constant long-run mean dose not find for spread process but trade towards it like other methods of pairs trading and the only needed assumption is remaining constant of statistical properties of the spread process volatility. In this research, profitability of proposed method have been proved theoretically mean-reverting process with stochastic volatility , then pairs trading  have been performed based on this approach on selective data of Tehran stock exchange . The results of implementation show that used strategy obtain 52.91% per return in stock pair of KHTRAC and KHTOGHA, 33.645 per return in stock pair of KHMOHAREKEH and KHODRO for appropriate selection of H.