Optimal pairs trading with dynamic mean-variance objective

Dong-Mei Zhu, Jia-Wen Gu, Feng-Hui Yu*, Tak-Kuen Siu, Wai-Ki Ching

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

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Abstract

Pairs trading is a typical example of a convergence trading strategy. Investors buy relatively under-priced assets simultaneously, and sell relatively over-priced assets to exploit temporary mispricing. This study examines optimal pairs trading strategies under symmetric and non-symmetric trading constraints. Under the assumption that the price spread of a pair of correlated securities follows a mean-reverting Ornstein-Uhlenbeck(OU) process, analytical trading strategies are obtained under a mean-variance(MV) framework. Model estimation and empirical studies on trading strategies have been conducted using data on pairs of stocks and futures traded on China’s securities market. These results indicate that pairs trading strategies have fairly good performance.

Original languageEnglish
Pages (from-to)145-168
Number of pages24
JournalMathematical Methods of Operations Research
Volume94
Issue number1
Early online date25 Aug 2021
DOIs
Publication statusPublished - Aug 2021

Bibliographical note

Copyright © The Author(s) 2021. Version archived for private and non-commercial use with the permission of the author/s and according to publisher conditions. For further rights please contact the publisher.

Keywords

  • Dynamic mean-variance (MV)
  • Ornstein-Uhlenbeck (OU)
  • Pairs trading
  • Time inconsistency

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