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A pairs trading strategy based on mixed copulas

Author

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  • Sabino da Silva, Fernando A.B.
  • Ziegelmann, Flavio A.
  • Caldeira, João F.

Abstract

We propose an alternative pairs trading strategy based on computing a mispricing index in a novel way via a mixed copula model, or more specifically via an optimal linear combination of copulas. We evaluate the statistical and economic performances of our proposed approach by analyzing S&P 500 daily stock returns between 1990 and 2015. Empirical results are obtained not only from the full sample analysis but also from subperiods analyses. These subperiods are chosen in two different ways: i) fixed time length; and ii) bull/bear market dependent. Our empirical results suggest that overall the mixed copula strategy has a superior performance than the distance approach in terms of average returns and Sharpe ratio, considering or not the cost transaction. The superiority is more obvious during crisis periods.

Suggested Citation

  • Sabino da Silva, Fernando A.B. & Ziegelmann, Flavio A. & Caldeira, João F., 2023. "A pairs trading strategy based on mixed copulas," The Quarterly Review of Economics and Finance, Elsevier, vol. 87(C), pages 16-34.
    • Handle: RePEc:eee:quaeco:v:87:y:2023:i:c:p:16-34
    DOI: 10.1016/j.qref.2022.10.007
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    More about this item

    Keywords

    Pairs trading; Copula; Distance; Quantitative trading strategies; Long-short; Statistical arbitrage; Out-of-sample evaluation;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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