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On the Determinants of Pairs Trading Profitability

Last Updated on 10 February, 2024 by Rejaul Karim

Exploring the intricacies of pairs trading profitability, Heiko Jacobs and Martin Weber present an in-depth investigation in their forthcoming paper, “On the Determinants of Pairs Trading Profitability” in the Journal of Financial Markets.

The study commences with a cross-country analysis spanning 34 international stock markets, revealing the persistent nature of abnormal returns. Transitioning to a more focused examination of the U.S. market, the researchers delve into the underlying factors contributing to the intriguing profitability of pairs trading.

Their comprehensive findings emphasize the pivotal role of news types influencing pair divergence, the dynamic nature of investor attention, and the evolving landscape of limits to arbitrage. This research sheds light on the nuanced determinants shaping the time-varying performance of pairs trading, offering valuable insights for practitioners in the financial markets.

Abstract Of Paper

We perform a large-scale empirical analysis of pairs trading, a popular relative-value arbitrage approach. We start with a cross-country study of 34 international stock markets and uncover that abnormal returns are a persistent phenomenon. We then construct a comprehensive U.S. data set to explore the sources behind the puzzling profitability in more depth. Our findings indicate that the type of news leading to pair divergence, the dynamics of investor attention as well as the dynamics of limits to arbitrage are important drivers of the strategy’s time-varying performance.

Original paper – Download PDF

Here you can download the PDF and original paper of On the Determinants of Pairs Trading Profitability.

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Author

Heiko Jacobs
University of Duisburg-Essen, Campus Essen

Martin Weber
University of Mannheim – Department of Banking and Finance

Conclusion

In summary, our extensive empirical investigation into pairs trading, a widely adopted relative-value arbitrage strategy, brings forth compelling insights into its profitability determinants. Spanning 34 international stock markets, our cross-country study underscores the persistent nature of abnormal returns associated with pairs trading.

Delving deeper into the U.S. market, our comprehensive dataset illuminates key contributors to this profitability puzzle. We identify the type of news triggering pair divergence, the ebb and flow of investor attention, and the dynamics of limits to arbitrage as pivotal factors steering the strategy’s fluctuating performance over time.

These nuanced findings underscore the multifaceted nature of pairs trading profitability, providing practitioners and scholars with a more nuanced understanding of the intricate dynamics influencing this popular arbitrage approach.

Related Reading:

European Equity Pairs Trading: The Effect of Data Frequency on Risk and Return

Is Daily Pairs Trading of ETF-Stocks Profitable?

FAQ

– What does the cross-country analysis reveal about pairs trading abnormal returns?

The cross-country analysis spanning 34 international stock markets indicates that abnormal returns in pairs trading are a persistent phenomenon. The study underscores the enduring nature of the strategy’s profitability on a global scale, laying the foundation for a more in-depth exploration into the factors driving these abnormal returns.

– What are the key contributors to the profitability of pairs trading in the U.S. market?

The comprehensive U.S. dataset reveals several factors influencing the profitability of pairs trading. The research identifies the type of news leading to pair divergence, the dynamics of investor attention, and the evolving landscape of limits to arbitrage as crucial drivers of the strategy’s time-varying performance. These factors shed light on the nuanced determinants shaping pairs trading profitability specifically in the U.S. market.

– How do the findings of this research benefit practitioners in the financial markets?

The nuanced insights from this empirical investigation provide valuable information for practitioners in the financial markets. By understanding the persistent nature of abnormal returns in pairs trading and the specific factors influencing profitability, practitioners can make more informed decisions. The research highlights the intricate dynamics of news impact, investor attention, and limits to arbitrage, offering a nuanced perspective that can enhance the effectiveness of pairs trading strategies.

You can find many more Research Papers here

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