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Pairs trading: does volatility timing matter?

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  • Nicolas Huck

    (ICN Business School, CEREFIGE - Centre Européen de Recherche en Economie Financière et Gestion des Entreprises - UL - Université de Lorraine)

Abstract

Pairs trading is a dollar-neutral trading strategy. Using the components of two major stock indices, the S&P 500 and the Nikkei 225, this article deals with the performance of a pairs trading system based on various pairs selection methods (distance, stationarity, cointegration) over a 10-year period. On both markets, using a classical framework, cointegration appears superior and effective. On the U.S. market and also in Japan to a lower extent, pairs trading strategies exhibited an impressive performance during the 2008 financial crisis. Bearish periods are associated with a high level of the VIX index: the ‘investor fear gauge'. Using a modified trading system, this article examines the link between pairs trading performance and volatility/VIX timing. It is shown that for the best selection technique (cointegration), timing volatility has no economic value in a pairs trading context.

Suggested Citation

  • Nicolas Huck, 2015. "Pairs trading: does volatility timing matter?," Post-Print hal-01507986, HAL.
    • Handle: RePEc:hal:journl:hal-01507986
    DOI: 10.1080/00036846.2015.1068923
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    Cited by:

    1. Baoqiang Zhan & Shu Zhang & Helen S. Du & Xiaoguang Yang, 2022. "Exploring Statistical Arbitrage Opportunities Using Machine Learning Strategy," Computational Economics, Springer;Society for Computational Economics, vol. 60(3), pages 861-882, October.
    2. Krauss, Christopher & Do, Xuan Anh & Huck, Nicolas, 2017. "Deep neural networks, gradient-boosted trees, random forests: Statistical arbitrage on the S&P 500," European Journal of Operational Research, Elsevier, vol. 259(2), pages 689-702.
    3. Marianna Brunetti & Roberta De Luca, 2021. "Pairs Trading In The Index Options Market," CEIS Research Paper 512, Tor Vergata University, CEIS, revised 02 Sep 2021.
    4. Clegg, Matthew & Krauss, Christopher, 2016. "Pairs trading with partial cointegration," FAU Discussion Papers in Economics 05/2016, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    5. Matthew Clegg & Christopher Krauss, 2018. "Pairs trading with partial cointegration," Quantitative Finance, Taylor & Francis Journals, vol. 18(1), pages 121-138, January.
    6. Marianna Brunetti & Roberta De Luca, 2023. "Pairs trading in the index options market," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 13(1), pages 145-173, March.
    7. Krauss, Christopher, 2015. "Statistical arbitrage pairs trading strategies: Review and outlook," FAU Discussion Papers in Economics 09/2015, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    8. Marianna Brunetti & Roberta De Luca, 2022. "Sensitivity of Profitability in Cointegration-Based Pairs Trading," CEIS Research Paper 540, Tor Vergata University, CEIS, revised 11 Apr 2022.
    9. Jeff Stephenson & Bruce Vanstone & Tobias Hahn, 2021. "A Unifying Model for Statistical Arbitrage: Model Assumptions and Empirical Failure," Computational Economics, Springer;Society for Computational Economics, vol. 58(4), pages 943-964, December.
    10. Marianna Brunetti & Roberta de Luca, 2022. "Sensitivity of profitability in cointegration-based pairs trading," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0090, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    11. Fernando Caneo & Werner Kristjanpoller, 2021. "Improving statistical arbitrage investment strategy: Evidence from Latin American stock markets," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(3), pages 4424-4440, July.

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