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Simulated Trading-An Analysis of Pairs Trading

Author

Listed:
  • Nikesh Agarwal

    (Stockholm School of Economics)

  • Vikash Madhogaria

    (Stockholm School of Economics)

  • Supreena Narayanan

    (Stockholm School of Economics)

Abstract

In this report, we explain and analyze a trading strategy, popularly known as Pairs trading. We begin by explaining what a pair trading strategy entails. Since there are various ways of implementing the strategy, we describe the methodology selected by us in section 3. Thereafter, we look at the returns from the strategy and benchmark it to the S&P 500 index in Section 4. In section 5, we examine the risks involved in pairs trading. Section 6 looks at some of the limitations we faced while trading and Section 7 points out some mistakes we made. Finally, we discuss some risk control measures in Section 8 and conclude in Section 9 with comments on whether we would implement the strategy in real life and if so, with what changes.

Suggested Citation

  • Nikesh Agarwal & Vikash Madhogaria & Supreena Narayanan, 2004. "Simulated Trading-An Analysis of Pairs Trading," Finance 0412018, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0412018 Note: Type of Document - pdf; pages: 15
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    File URL: http://econwpa.repec.org/eps/fin/papers/0412/0412018.pdf
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    References listed on IDEAS

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    1. Barone-Adesi, Giovanni & Whaley, Robert E, 1987. " Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-320, June.
    2. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    3. DAI & Feng QIN & Zifu, 2005. "DF Structure Models for Options Pricing," The IUP Journal of Applied Economics, IUP Publications, vol. 0(6), pages 61-77, November.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Peter Carr & Robert Jarrow & Ravi Myneni, 2008. "Alternative Characterizations Of American Put Options," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 5, pages 85-103 World Scientific Publishing Co. Pte. Ltd..
    6. Geske, Robert & Roll, Richard, 1984. " On Valuing American Call Options with the Black-Scholes European Formula," Journal of Finance, American Finance Association, vol. 39(2), pages 443-455, June.
    7. Peter Ritchken & Rob Trevor, 1999. "Pricing Options under Generalized GARCH and Stochastic Volatility Processes," Journal of Finance, American Finance Association, vol. 54(1), pages 377-402, February.
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    JEL classification:

    • G - Financial Economics

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