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Pre-selection in cointegration-based pairs trading

Author

Listed:
  • Marianna Brunetti

    (University of Rome Tor Vergata, CEFIN & CEIS)

  • Roberta De Luca

    (Bank of Italy)

Abstract

The paper compares the final profitability of a cointegration-based pairs trading strategy when pairs of stocks are pre-selected by means of seven different measures. Some of the measures considered have been extensively used in the pairs trading literature, while others represent a novelty in this type of application. We find that pre-selection matters, since the excess returns remarkably vary, in terms of both average and variability, depending on the metrics used. Differences in profitability by pre-selection metrics are retrieved even after considering commissions and cut rules, market impact, a stricter definition of the Spread reversion to the equilibrium and alternative cointegration tests. Besides, the pairs trading profitability is found to be heterogeneous across the different pre-selection metrics also in terms of exposure to the systematic stock-market risk factors.

Suggested Citation

  • Marianna Brunetti & Roberta De Luca, 2023. "Pre-selection in cointegration-based pairs trading," Statistical Methods & Applications, Springer;Società Italiana di Statistica, vol. 32(5), pages 1611-1640, December.
    • Handle: RePEc:spr:stmapp:v:32:y:2023:i:5:d:10.1007_s10260-023-00702-4
    DOI: 10.1007/s10260-023-00702-4
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    More about this item

    Keywords

    Pairs trading; Pre-selection; Cointegration; Spectral coherence; Risk factors;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C40 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - General
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General

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