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Evaluation of pairs trading strategy at the Brazilian financial market

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  • Perlin, M.

Abstract

Pairs trading is a popular trading strategy that tries to take advantage of market inefficiencies in order to obtain profit. The idea is simple: find two stocks that move together and take long/short positions when they diverge abnormally, hoping that the prices will converge in the future. From the academic point of view of weak market efficiency theory, pairs trading strategy shouldn’t present positive performance since, according to it, the actual price of a stock reflects its past trading data, including historical prices. This leaves us with a question, does pairs trading strategy presents positive performance for the Brazilian market? The main objective of this research is to verify the performance and risk of pairs trading in the Brazilian financial market for different frequencies of the database, daily, weekly and monthly prices for the same time period. The main conclusion of this simulation is that pairs trading strategy was a profitable and market neutral strategy at the Brazilian Market. Such profitability was consistent over a region of the strategy’s parameters. The best results were found for the highest frequency (daily), which is an intuitive result.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 8308.

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Date of creation: 01 Dec 2007
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Handle: RePEc:pra:mprapa:8308

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Keywords: pairs trading; quantitative strategy; asset allocation;

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  1. William N. Goetzmann & Evan Geov Gatev & K. Geert Rouwenhorst, 1998. "Pairs Trading: Performance of a Relative Value Arbitrage Rule," Yale School of Management Working Papers ysm109, Yale School of Management.
  2. Fernando Fernandez-Rodriguez & Simon Sosvilla-Rivero & Maria Dolores Garcia-Artiles, 1997. "Using nearest neighbour predictors to forecast the Spanish stock market," Investigaciones Economicas, Fundación SEPI, vol. 21(1), pages 75-91, January.
  3. Elroy Dimson & Massoud Mussavian, 1998. "A brief history of market efficiency," European Financial Management, European Financial Management Association, vol. 4(1), pages 91-103.
  4. Michael Dueker & Christopher J. Neely, 2006. "Can Markov switching models predict excess foreign exchange returns?," Working Papers 2001-021, Federal Reserve Bank of St. Louis.
  5. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  6. Park, Cheol-Ho & Irwin, Scott H., 2004. "The Profitability of Technical Analysis: A Review," AgMAS Project Research Reports 37487, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
  7. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
  8. French, Kenneth R., 1980. "Stock returns and the weekend effect," Journal of Financial Economics, Elsevier, vol. 8(1), pages 55-69, March.
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Cited by:
  1. Perlin, M., 2007. "M of a kind: A Multivariate Approach at Pairs Trading," MPRA Paper 8309, University Library of Munich, Germany.
  2. Bolgun, Evren & Kurun, Engin & Guven, Serhat, 2009. "Dynamic Pairs Trading Strategy For The Companies Listed In The Istanbul Stock Exchange," MPRA Paper 19887, University Library of Munich, Germany.
  3. Fabio Pizzutilo, 2013. "A Note on the Effectiveness of Pairs Trading For Individual Investors," International Journal of Economics and Financial Issues, Econjournals, vol. 3(3), pages 763-771.

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