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Pairs Trading under Geometric Brownian Motion Models

In: Stochastic Analysis, Filtering, and Stochastic Optimization

Author

Listed:
  • Phong Luu

    (University of North Georgia, Department of Mathematics)

  • Jingzhi Tie

    (University of Georgia, Department of Mathematics)

  • Qing Zhang

    (University of Georgia, Department of Mathematics)

Abstract

This survey paper is concerned with pairs trading strategies under geometric Brownian motion models. Pairs trading is about trading simultaneously a pair of securities, typically stocks. The idea is to monitor the spread of their price movements over time. A pairs trade is triggered by their price divergence (e.g., one stock moves up a significant amount relative to the other) and consists of a short position in the strong stock and a long position in the weak one. Such a strategy bets on the reversal of their price strengths and the eventual convergence of the price spread. Pairs trading is popular among trading institutions because its risk neutral nature. In practice, the trader needs to decide when to initiate a pairs position (how much divergence is enough) and when to close the position (how to take profits or cut losses). It is the main goals of this paper to address these issues and theoretical findings along with related practical considerations.

Suggested Citation

  • Phong Luu & Jingzhi Tie & Qing Zhang, 2022. "Pairs Trading under Geometric Brownian Motion Models," Springer Books, in: George Yin & Thaleia Zariphopoulou (ed.), Stochastic Analysis, Filtering, and Stochastic Optimization, pages 357-380, Springer.
    • Handle: RePEc:spr:sprchp:978-3-030-98519-6_15
    DOI: 10.1007/978-3-030-98519-6_15
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