Perlin, M. (2007): Evaluation of pairs trading strategy at the Brazilian financial market.
Download (158kB) | Preview
Pairs trading is a popular trading strategy that tries to take advantage of market inefficiencies in order to obtain profit. The idea is simple: find two stocks that move together and take long/short positions when they diverge abnormally, hoping that the prices will converge in the future. From the academic point of view of weak market efficiency theory, pairs trading strategy shouldn’t present positive performance since, according to it, the actual price of a stock reflects its past trading data, including historical prices. This leaves us with a question, does pairs trading strategy presents positive performance for the Brazilian market? The main objective of this research is to verify the performance and risk of pairs trading in the Brazilian financial market for different frequencies of the database, daily, weekly and monthly prices for the same time period. The main conclusion of this simulation is that pairs trading strategy was a profitable and market neutral strategy at the Brazilian Market. Such profitability was consistent over a region of the strategy’s parameters. The best results were found for the highest frequency (daily), which is an intuitive result.
|Item Type:||MPRA Paper|
|Original Title:||Evaluation of pairs trading strategy at the Brazilian financial market|
|Keywords:||pairs trading, quantitative strategy, asset allocation|
|Subjects:||C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C10 - General
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions
|Depositing User:||Marcelo Perlin|
|Date Deposited:||17. Apr 2008 17:11|
|Last Modified:||12. Feb 2013 11:11|
ANDERSON, K., BROOKS, C. (2006) ‘Decomposing the Price-Earnings Ratio’, Journal of Asset Management, v. 6, p. 456-469.
BALSARA, N., ZHENG, L. (2006) ‘Profiting from Past Winners and Losers’, Journal of Asset Management. V.6, p. 329-344.
BROOKS, C., KATSARIS, A., PERSAND, G. (2005) ‘Timing is Everything: A Comparison and Evaluation of Market Timing Strategies’, Working Paper, Available at SSRN: http://ssrn.com/abstract=834485.
CHEN, A., LEUNG, M. T., DAOUK, H. (2003) ‘Application of Neural Networks to an Emerging Financial Market: Forecasting and Trading the Taiwan Stock Index’. Computers & Operations Research, v. 30, p. 901–923.
DIMSON, E., MUSSAVIAN, M. (1998) ‘A brief history of market efficiency’. European Financial Management, v. 4, p. 91-193.
DUEKER, M. J., NEELY, C. J. (2006) ‘Can Markov Switching Models Predict Excess Foreign Exchange Returns?’, Working Paper, Federal Reserve Bank of St. Louis.
EFETKHARI, B. (1997) ‘The Markov Regime Switching model as Trading Tool’, Working Paper, University of Cambridge. FAMA, E. (1991) ‘Efficient Capital Markets: II’, Journal of Finance, v. 46, p. 1575-1617.
FAMA, E., FRENCH, K. (1992) ‘The cross-section of expected stock returns’, Journal of Finance, v. 47 (2), p. 427-465.
FERNÁNDEZ-RODRÍGUEZ, F., RIVERO, S. S., FELIX, J. A. (2002) ‘Nearest Neighbor Predictions in Foreign Exchange Markets’, Working Paper, n. 05, FEDEA.
FERNÁNDEZ-RODRÍGUEZ, F., SOSVILLA-RIVERO, S., GARCÍA-ARTILES, M. (1997) ‘Using nearest neighbor predictors to forecast the Spanish Stock Market’, Investigaciones Económicas, v. 21, p. 75-91.
FERNÁNDEZ-RODRÍGUEZ, F., SOSVILLA-RIVERO, S., GARCÍA-ARTILES, M. (2001) ‘An empirical evaluation of non-linear trading rules’, Working Paper, n. 16, FEDEA.
FRENCH, K. (1980) ‘Stock Returns and the Weekend Effect’, Journal of Financial Economics, March, p. 55-69.
GATEV, E., GOETZMANN, W. N., ROUWENHORST, K. G. (1999) ‘Pairs Trading: Performance of a Relative Value Arbitrage Rule’, Working Paper, Yale School of Management. Available at SSRN: http://ssrn.com/abstract=141615.
MURPHY, J. (1999) Technical Analysis of the Financial Markets, New York Institute of Finance, New York.
NATH, P. (2003) ‘High Frequency Pairs Trading with U.S. Treasury Securities: Risks and Rewards for Hedge Funds’, Working Paper, London Business School.
PARK, C., IRWIN, C. (2004) ‘The Profitability of Technical Analysis: A Review’. AgMAS Project Research Report, n. 04.
PERLIN, M. S. (2006) ‘Non Parametric Modelling in Major Latin America Market Indexes: An Analysis of the Performance from the Nearest Neighbor Algorithm in Trading Strategies’, BALAS Conference, Lima/Peru.
SIGANOS, A., CHELLEY-STEELEY, P. (2006) ‘Momentum Profits Following Bull and Bear Markets’, Journal of Asset Management, V. 6, p. 381-388.
VIDYAMURTHY, G. (2004) Pairs Trading: Quantitative Methods and Analysis, John Wiley & Sons.