The profitability of pairs training strategies: distance, cointegration and copula methods

Rad, Hossein, Low, Rand Kwong Yew and Faff, Robert (2016) The profitability of pairs training strategies: distance, cointegration and copula methods. Quantitative Finance, 16 10: 1541-1558. doi:10.1080/14697688.2016.1164337

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Author Rad, Hossein
Low, Rand Kwong Yew
Faff, Robert
Title The profitability of pairs training strategies: distance, cointegration and copula methods
Journal name Quantitative Finance   Check publisher's open access policy
ISSN 1469-7688
1469-7696
Publication date 2016-04-27
Year available 2016
Sub-type Article (original research)
DOI 10.1080/14697688.2016.1164337
Open Access Status Not Open Access
Volume 16
Issue 10
Start page 1541
End page 1558
Total pages 18
Place of publication Abingdon, Oxon, United Kingdom
Publisher Routledge
Collection year 2017
Language eng
Formatted abstract
We perform an extensive and robust study of the performance of three different pairs trading strategies—the distance, cointegration and copula methods—on the entire US equity market from 1962 to 2014 with time-varying trading costs. For the cointegration and copula methods, we design a computationally efficient two-step pairs trading strategy. In terms of economic outcomes, the distance, cointegration and copula methods show a mean monthly excess return of 91, 85 and 43 bps (38, 33 and 5 bps) before transaction costs (after transaction costs), respectively. In terms of continued profitability, from 2009, the frequency of trading opportunities via the distance and cointegration methods is reduced considerably, whereas this frequency remains stable for the copula method. Further, the copula method shows better performance for its unconverged trades compared to those of the other methods. While the liquidity factor is negatively correlated to all strategies’ returns, we find no evidence of their correlation to market excess returns. All strategies show positive and significant alphas after accounting for various risk-factors. We also find that in addition to all strategies performing better during periods of significant volatility, the cointegration method is the superior strategy during turbulent market conditions.
Keyword Pairs trading
Copula
Cointegration
Quantitative strategies
Statistical arbitrage
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status UQ

Document type: Journal Article
Sub-type: Article (original research)
Collections: HERDC Pre-Audit
UQ Business School Publications
 
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Created: Mon, 11 Apr 2016, 09:41:10 EST by Karen Morgan on behalf of UQ Business School