Profitability of pairs trading strategy in an illiquid market with multiple share classes

John Paul Broussard, Mika Vaihekoski

Research output: Contribution to journalArticleScientificpeer-review

21 Citations (Scopus)

Abstract

We investigate the practical issues of implementing the self-financing pairs portfolio trading strategy presented by Gatev et al. (2006). We also provide new evidence on the profitability of pairs trading under different weighting structures and trade initiation conditions. Using data from the Finnish stock market over the period 1987-2008, we find pairs trading to be profitable even after allowing for a one day delay in the trade initiation after the signal. On average, the annualized return can be as high as 12.5%, though requiring trading on days a pair is traded lowers the return approximately by three percentage points. On the other hand, lowering the threshold for opening a pair is found to increase returns even after accounting for trading costs, indicating that there might be a more optimal trade initiation threshold available than that presented in earlier literature. The profits are not related to market risk. Pairs trading strategy is found to produce positive alpha during the sample period.
Original languageEnglish
Peer-reviewed scientific journalJournal of International Financial Markets, Institutions & Money
Volume22
Issue number5
Pages (from-to)1188-1201
Number of pages14
ISSN1042-4431
DOIs
Publication statusPublished - 2012
MoE publication typeA1 Journal article - refereed

Keywords

  • 512 Business and Management

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