IDEAS home Printed from https://ideas.repec.org/a/oup/rfinst/v26y2013i4p1048-1086.html
   My bibliography  Save this article

Optimal Convergence Trade Strategies

Author

Listed:
  • Jun Liu
  • Allan Timmermann

Abstract

Convergence trades exploit temporary mispricing by simultaneously buying relatively underpriced assets and selling short relatively overpriced assets. This paper studies optimal convergence trades under both recurring and nonrecurring arbitrage opportunities represented by continuing and "stopped" cointegrated price processes and considers both fixed and stochastic (Poisson) horizons. Conventional long-short delta neutral strategies are generally suboptimal and it can be optimal to simultaneously go long (or short) in two mispriced assets. Optimal portfolio holdings critically depend on whether the risky asset position is liquidated when prices converge. Our theoretical results are illustrated on pairs of Chinese bank shares traded on both the Hong Kong and China stock exchanges. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Jun Liu & Allan Timmermann, 2013. "Optimal Convergence Trade Strategies," Review of Financial Studies, Society for Financial Studies, vol. 26(4), pages 1048-1086.
  • Handle: RePEc:oup:rfinst:v:26:y:2013:i:4:p:1048-1086
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/rfs/hhs130
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Chen, Zhimin & Ibragimov, Rustam, 2019. "One country, two systems? The heavy-tailedness of Chinese A- and H- share markets," Emerging Markets Review, Elsevier, vol. 38(C), pages 115-141.
    2. Law, K.F. & Li, W.K. & Yu, Philip L.H., 2018. "A single-stage approach for cointegration-based pairs trading," Finance Research Letters, Elsevier, vol. 26(C), pages 177-184.
    3. Bahman Angoshtari, 2016. "On the Market-Neutrality of Optimal Pairs-Trading Strategies," Papers 1608.08268, arXiv.org.
    4. Groenborg, Niels & Lunde, Asger & Timmermann, Allan G & Wermers, Russ, 2017. "Picking Funds with Confidence," CEPR Discussion Papers 11896, C.E.P.R. Discussion Papers.
    5. Gu, Ailing & Viens, Frederi G. & Yao, Haixiang, 2018. "Optimal robust reinsurance-investment strategies for insurers with mean reversion and mispricing," Insurance: Mathematics and Economics, Elsevier, vol. 80(C), pages 93-109.
    6. Hugonnier, Julien & Prieto, Rodolfo, 2015. "Asset pricing with arbitrage activity," Journal of Financial Economics, Elsevier, vol. 115(2), pages 411-428.
    7. Chen, Cathy W.S. & Wang, Zona & Sriboonchitta, Songsak & Lee, Sangyeol, 2017. "Pair trading based on quantile forecasting of smooth transition GARCH models," The North American Journal of Economics and Finance, Elsevier, vol. 39(C), pages 38-55.
    8. Niels S. Grønborg & Asger Lunde & Allan Timmermann & Russ Wermers, 2017. "Picking Funds with Confidence," CREATES Research Papers 2017-13, Department of Economics and Business Economics, Aarhus University.
    9. Suhan Altay & Katia Colaneri & Zehra Eksi, 2019. "Optimal Convergence Trading with Unobservable Pricing Errors," Papers 1910.01438, arXiv.org, revised Oct 2019.
    10. Gu, Ailing & Viens, Frederi G. & Yi, Bo, 2017. "Optimal reinsurance and investment strategies for insurers with mispricing and model ambiguity," Insurance: Mathematics and Economics, Elsevier, vol. 72(C), pages 235-249.
    11. 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.
    12. Bahman Angoshtari & Tim Leung, 2019. "Optimal dynamic basis trading," Annals of Finance, Springer, vol. 15(3), pages 307-335, September.
    13. Lei, Yaoting & Xu, Jing, 2015. "Costly arbitrage through pairs trading," Journal of Economic Dynamics and Control, Elsevier, vol. 56(C), pages 1-19.
    14. Dilip Patro & Louis R. Piccotti & Yangru Wu, 2017. "Exploiting Closed-End Fund Discounts: A Systematic Examination Of Alphas," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 40(2), pages 223-248, June.
    15. Bo Yi & Frederi Viens & Baron Law & Zhongfei Li, 2015. "Dynamic portfolio selection with mispricing and model ambiguity," Annals of Finance, Springer, vol. 11(1), pages 37-75, February.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:rfinst:v:26:y:2013:i:4:p:1048-1086. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press). General contact details of provider: http://edirc.repec.org/data/sfsssea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.