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March 2014 Pairs trading with opportunity cost
Carl Lindberg
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J. Appl. Probab. 51(1): 282-286 (March 2014). DOI: 10.1239/jap/1395771429

Abstract

Pairs trading is a trading strategy which is used very frequently in the financial industry. An investment opportunity arises when the spread between two assets, which historically have exhibited autoregressive behavior, deviates from its recent history. In this case, the investor takes a long position in the asset which is expected to outperform going forward and finances this by taking a short position in the other one. If the spread converges, the investor can close both positions to generate a profit. We model the spread between two assets as an Ornstein-Uhlenbeck process and assume a constant opportunity cost. We then study the optimal liquidation strategy for an investor who wants to optimize profit in excess of the opportunity cost. Including this cost is important from an applied perspective, as the performance of any investment is always evaluated relative to the performance of the opportunity set.

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Carl Lindberg. "Pairs trading with opportunity cost." J. Appl. Probab. 51 (1) 282 - 286, March 2014. https://doi.org/10.1239/jap/1395771429

Information

Published: March 2014
First available in Project Euclid: 25 March 2014

zbMATH: 1291.91248
MathSciNet: MR3189457
Digital Object Identifier: 10.1239/jap/1395771429

Subjects:
Primary: 60G40, 91G80

Rights: Copyright © 2014 Applied Probability Trust

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Vol.51 • No. 1 • March 2014
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