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Optimal Convergence Trading


  • Vladislav KArgin


This article examines arbitrage investment in a mispriced asset when the mispricing follows the Ornstein-Uhlenbeck process and a credit- constrained investor maximizes a generalization of the Kelly criterion. The optimal differentiable and threshold policies are derived. The optimal differentiable policy is linear with respect to mispricing and risk-free in the long run. The optimal threshold policy calls for investing immediately when the mispricing is greater than zero with the investment amount inversely proportional to the risk aversion parameter. The investment is risky even in the long run. The results are consistent with the belief that credit-constrained arbitrageurs should be risk- neutral if they are to engage in convergence trading.

Suggested Citation

  • Vladislav KArgin, 2004. "Optimal Convergence Trading," Finance 0401003, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0401003
    Note: Type of Document - pdf; prepared on Win2000; pages: 24; figures: 6

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    References listed on IDEAS

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    4. Jun Liu, 2004. "Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities," Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 611-641.
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    Cited by:

    1. repec:wsi:ijtafx:v:13:y:2010:i:01:n:s0219024910005693 is not listed on IDEAS
    2. Yingdong Lv & Bernhard K. Meister, 2009. "Application of the Kelly Criterion to Ornstein-Uhlenbeck Processes," Papers 0903.2910,

    More about this item


    arbitrage; leverage; investment strategy;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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