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Financial Markets and Portfolio Management

, Volume 31, Issue 1, pp 1–26 | Cite as

A good pair: alternative pairs-trading strategies

  • R. Todd SmithEmail author
  • Xun Xu
Article

Abstract

This paper studies alternative techniques for identifying stock pairs in a pairs-trading strategy over 1980–2014. We consider two main techniques: the distance approach and the cointegration approach. We also consider a range of parameterizations of the trading system design. Parameterization of the trading system matters for the profitability of pairs trading. We find that the cointegration approach, despite using an optimal in-sample parameterization, yields significant returns only in the 1980s. The distance approach performs better, producing significantly positive risk-adjusted returns in all sub-periods. However, when transaction costs are properly taken into account, the returns largely disappear in recent years.

Keywords

Stocks Pairs trading Investing Arbitrage 

JEL Classification

G1 

Notes

Acknowledgements

We are grateful to two referees for suggestions. This paper represents the views of the authors and does not represent the views, practices, or policies of Vestcor Investment Management Corporation.

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Copyright information

© Swiss Society for Financial Market Research 2017

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of AlbertaEdmontonCanada
  2. 2.Vestcor Investment Management CorporationFrederictonCanada

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