Does simple pairs trading still work?

Do, Binh and Faff, Robert (2010) Does simple pairs trading still work?. Financial Analysts Journal, 66 4: 83-95. doi:10.2469/faj.v66.n4.1

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Author Do, Binh
Faff, Robert
Title Does simple pairs trading still work?
Journal name Financial Analysts Journal   Check publisher's open access policy
ISSN 0015-198X
Publication date 2010-07
Sub-type Article (original research)
DOI 10.2469/faj.v66.n4.1
Volume 66
Issue 4
Start page 83
End page 95
Total pages 13
Editor Richard M. Ennis
Robert Litterman
Rodney N. Sullivan
Place of publication Charlottesville, VA, United States
Publisher CFA Institute
Collection year 2011
Language eng
Abstract We re-examine and enhance evidence on ‘pairs trading’ most prominently documented in US markets by Gatev, Goeztmann and Rouwenhorst (1999, 2006). Extending their original analysis to June 2008, we confirm a continuation of the declining trend in profitability. However, contrary to popular belief, we find that the rise in hedge fund activity is not a plausible explanation for the decline. Instead, we observe that the underlying convergence properties are less reliable there is an increased probability that a pair of close substitutes over the past 12 months are no longer close substitutes in the subsequent half year. This fragility in the Law of One Price dynamics reflects increased fundamental risks, or uncertainty in market perception of relative values of the paired securities. Nevertheless, we still find more than half the selected pairs are either profitable or very profitable. Moreover, we demonstrate some success in identifying these successful cases by augmenting the original pair matching method to incorporate the time series aspect of historical prices, and/or by focusing on industries with a high level of homogeneity.
Formatted abstract

Keyword Pairs trading
Convergence trading
Law of one price
Statistical arbitrage
Q-Index Code C1
Q-Index Status Confirmed Code
Institutional Status UQ
Additional Notes Published July/August 2010.

Document type: Journal Article
Sub-type: Article (original research)
Collections: Faculty of Business, Economics and Law -- Publications
Official 2011 Collection
UQ Business School Publications
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Citation counts: TR Web of Science Citation Count  Cited 7 times in Thomson Reuters Web of Science Article | Citations
Scopus Citation Count Cited 22 times in Scopus Article | Citations
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Created: Thu, 28 Oct 2010, 15:46:40 EST by Karen Morgan on behalf of UQ Business School