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The profitability of pairs trading strategies on Hong-Kong stock market: distance, cointegration, and correlation methods

Author

Listed:
  • Baiquan Ma

    (University of Warsaw, Faculty of Economic Sciences, Quantitative Finance Research Group)

  • Robert Ślepaczuk

    (University of Warsaw, Faculty of Economic Sciences, Quantitative Finance Research Group, Department of Quantitative Finance)

Abstract

This research aims to compare the profitability of correlation-based pair trading strategy, cointegration-based pair trading strategy, and distance-based pair trading strategy on the Hong Kong stock market. We try to build an effective pair trading strategy based on 50 stocks listed in the Hang Seng index joining them in market-neutral pairs. The dataset has a daily frequency and covers the period from 07/01/2013 to 07/01/2020. The result shows that all three methods are profitable in the Hong Kong stock market and can beat the market with regard to risk-adjusted return metrics. This result is quite sensitive to the varying number of pairs traded and rebalancing period and less sensitive to financial leverage degree. Moreover, the cointegration method is superior as compared to the correlation method and distance method.

Suggested Citation

  • Baiquan Ma & Robert Ślepaczuk, 2022. "The profitability of pairs trading strategies on Hong-Kong stock market: distance, cointegration, and correlation methods," Working Papers 2022-02, Faculty of Economic Sciences, University of Warsaw.
    • Handle: RePEc:war:wpaper:2022-02
    as

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    File URL: https://www.wne.uw.edu.pl/download_file/1240/0
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    References listed on IDEAS

    as
    1. Binh Do & Robert Faff, 2012. "Are Pairs Trading Profits Robust To Trading Costs?," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 35(2), pages 261-287, June.
    2. Nicolas Huck & Komivi Afawubo, 2015. "Pairs trading and selection methods: is cointegration superior?," Applied Economics, Taylor & Francis Journals, vol. 47(6), pages 599-613, February.
    3. Evan Gatev & William N. Goetzmann & K. Geert Rouwenhorst, 2006. "Pairs Trading: Performance of a Relative-Value Arbitrage Rule," The Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 797-827.
    4. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 39(3), pages 106-135.
    5. Bui, Quynh & Ślepaczuk, Robert, 2022. "Applying Hurst Exponent in pair trading strategies on Nasdaq 100 index," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 592(C).
    6. Hossein Rad & Rand Kwong Yew Low & Robert Faff, 2016. "The profitability of pairs trading strategies: distance, cointegration and copula methods," Quantitative Finance, Taylor & Francis Journals, vol. 16(10), pages 1541-1558, October.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    algorithmic trading strategies; robust optimisation criteria; overoptimisation; walk-forward optimisation; ensemble investment model;
    All these keywords.

    JEL classification:

    • C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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