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Pre-selection in Cointegration-based Pairs Trading

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Abstract

This paper compares the final profitability of a cointegration-based pairs trading strategy when pairs of stocks are pre-selected using seven different measures. Pre-selection matters, since the excess returns remarkably vary, in terms of both average and variability, depending on the metrics used. Differences in profitability by pre-selection metrics are retrieved even after considering commissions and cut rules, market impact, and a stricter definition of the Spread reversion to the equilibrium. Besides, the profitability of the pairs trading strategy is also found heterogeneous across the different pre-selection metrics considered in terms of exposure to the traditional risk-factors.

Suggested Citation

  • Marianna Brunetti & Roberta De Luca, 2020. "Pre-selection in Cointegration-based Pairs Trading," CEIS Research Paper 500, Tor Vergata University, CEIS, revised 10 Mar 2021.
    • Handle: RePEc:rtv:ceisrp:500
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    More about this item

    Keywords

    pairs trading; pre-selection; cointegration; profitability;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis

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