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Optimal closing of a pair trade with a model containing jumps

  • Stig Larsson
  • Carl Lindberg
  • Marcus Warfheimer
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    A pair trade is a portfolio consisting of a long position in one asset and a short position in another, and it is a widely applied investment strategy in the financial industry. Recently, Ekstr\"om, Lindberg and Tysk studied the problem of optimally closing a pair trading strategy when the difference of the two assets is modelled by an Ornstein-Uhlenbeck process. In this paper we study the same problem, but the model is generalized to also include jumps. More precisely we assume that the above difference is an Ornstein-Uhlenbeck type process, driven by a L\'evy process of finite activity. We prove a verification theorem and analyze a numerical method for the associated free boundary problem. We prove rigorous error estimates, which are used to draw some conclusions from numerical simulations.

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    File URL: http://arxiv.org/pdf/1004.2947
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    Paper provided by arXiv.org in its series Papers with number 1004.2947.

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    Date of creation: Apr 2010
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    Publication status: Published in Appl. Math. 58 (2013), 249-268
    Handle: RePEc:arx:papers:1004.2947
    Contact details of provider: Web page: http://arxiv.org/

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