arXiv 24 Nov 2019 · Finance — Trading · publishedJournal of risk and financial management (2022) · 1 citations (OpenAlex)
arXiv:1911.10450 · PDF · DOI · OpenAlex · Extracted main text
Optimal trading strategies for pairs trading have been studied by models that try to find either optimal shares of stocks by assuming no transaction costs or optimal timing of trading fixed numbers of shares of stocks with transaction costs. To find optimal strategies which determine optimally both trade times and number of shares in pairs trading process, we use a singular stochastic control approach to study an optimal pairs trading problem with proportional transaction costs. Assuming a cointegrated relationship for a pair of stock log-prices, we consider a portfolio optimization problem which involves dynamic trading strategies with proportional transaction costs. We show that the value function of the control problem is the unique viscosity solution of a nonlinear quasi-variational inequality, which is equivalent to a free boundary problem for the singular stochastic control value function. We then develop a discrete time dynamic programming algorithm to compute the transaction regions, and show the convergence of the discretization scheme. We illustrate our approach with numerical examples and discuss the impact of different parameters on transaction regions. We study the out-of-sample performance in an empirical study that consists of six pairs of U.S. stocks selected from different industry sectors, and demonstrate the efficiency of the optimal strategy.
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The works this paper leans on most, across its whole bibliography — not restricted to papers in our corpus. Ranked by composite intensity, which combines how often a work is mentioned, how many sections mention it, and how much of that falls in the main text rather than the appendix.
| Reference | Intensity | Mentions | Sections | Main text | |
|---|---|---|---|---|---|
| 1 | S. Mudchanatongsuk, J. Primbs, and W. Wong (2008) Optimal pairs trading: A stochastic approach | 0.874 | 6 | 2 | 100% |
| 2 | E. Gatev, W. N. Goetzmann, and K. G. Rouwenhorst (2006) Pairs trading: Performance of a relative-value arbitrage rule | 0.843 | 3 | 3 | 100% |
| 3 | Y. Lei and J. Xu (2015) Costly arbitrage through pairs trading | 0.737 | 3 | 2 | 100% |
| 4 | M. Ngo and H. Pham (2016) Optimal switching for the pairs trading rule: A viscosity solutions approach | 0.737 | 3 | 2 | 100% |
| 5 | G. Vidyamurthy (2004) Pairs Trading –- Quantitative Methods and Analysis | 0.644 | 2 | 2 | 100% |
| 6 | D. Ehrman (2006) The Handbook of Pairs Trading: Strategies Using Equities, Options, and Futures | 0.405 | 1 | 1 | 100% |
| 7 | R. Elliott, J. Van der Hoek, and W. Malcom (2005) Pairs trading | 0.405 | 1 | 1 | 100% |
| 8 | T. Leung and X. Li (2015) Optimal mean reversion trading with transaction costs and stop-loss exit | 0.405 | 1 | 1 | 100% |
| 9 | Q. Song and R. Yan (2013) An optimal pairs-trading | 0.405 | 1 | 1 | 100% |
| 10 | A. Tourin and R. Yan (2013) Dynamic pairs trading using the stochastic control approach | 0.405 | 1 | 1 | 100% |
Showing the top 10 of 14 scored citations.