Pairs trading: is it applicable to exchange-traded funds?

Tokat, Ekin; Hayrullahoğlu, Ahmet Cevdet

doi:10.1016/j.bir.2021.08.001

Cited by 6 publications

(5 citation statements)

References 18 publications

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“…The underlying idea is that the stock below the median PER is undervalued and signifies potential for higher returns [ 21 , 22 ]. The choice of pairs was made through Johansen cointegration, which is the most effective way to identify stocks that move together [ 15 ]. In each year, we formulated all pairs

of the selected stocks and assessed each pair for cointegration.…”

Section: Methodsmentioning

confidence: 99%

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An Entropic Approach for Pair Trading in PSX

Amer

Islam

2023

Entropy

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The perception in pair trading is to recognize that when two stocks move together, their prices will converge to a mean value in the future. However, finding the mean-reverted point at which the value of the pair will converge as well as the optimal boundaries of the trade is not easy, as uncertainty and model misspecifications may lead to losses. To cater to these problems, this study employed a novel entropic approach that utilizes entropy as a penalty function for the misspecification of the model. The use of entropy as a measure of risk in pair trading is a nascent idea, and this study utilized daily data for 64 companies listed on the PSX for the years 2017, 2018, and 2019 to compute their returns based on the entropic approach. The returns to these stocks were then evaluated and compared with the buy and hold strategy. The results show positive and significant returns from pair trading using an entropic approach. The entropic approach seems to have an edge to buy and hold, distance-based, and machine learning approaches in the context of the Pakistani market.

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of the selected stocks and assessed each pair for cointegration.…”

Section: Methodsmentioning

confidence: 99%

“…This is a robust method, as it directly tackles model misspecification [ 14 ] and provides a more persuasive solution. The choice of pairs is made through cointegration, the most effective way to identify stocks that move together [ 15 ]. Entropy has a wide application in finance as well [ 16 , 17 , 18 ].…”

Section: Introductionmentioning

confidence: 99%

An Entropic Approach for Pair Trading in PSX

Amer

Islam

2023

Entropy

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“…Their results suggest that pairs trading yields average annualized excess returns of approximately 11%. Likewise, Tokat and Hayrullahoglu (2022) apply pairs trading to a portfolio of 45 pairs. They find an average annual return of 15% with an average Sharpe ratio of 1.43 after considering transaction costs.…”

Section: Trading the Spreadmentioning

confidence: 99%

Cointegrated Portfolios and Volatility modeling in the Cryptocurrency Market

Gabriel,

Kunst

2024

SSRN Journal

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“…Transaction costs: High-frequency trading involves frequent trading, which can lead to higher transaction costs as shown by [8]. Such costs can negate the potential profits of pairs trading, suggesting that low-profit trades should be avoided.…”

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confidence: 99%

Machine Learning-Enhanced Pairs Trading

Hadad,

Hodarkar,

Lemeneh

et al. 2024

Forecasting

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Forecasting returns in financial markets is notoriously challenging due to the resemblance of price changes to white noise. In this paper, we propose novel methods to address this challenge. Employing high-frequency Brazilian stock market data at one-minute granularity over a full year, we apply various statistical and machine learning algorithms, including Bidirectional Long Short-Term Memory (BiLSTM) with attention, Transformers, N-BEATS, N-HiTS, Convolutional Neural Networks (CNNs), and Temporal Convolutional Networks (TCNs) to predict changes in the price ratio of closely related stock pairs. Our findings indicate that a combination of reversion and machine learning-based forecasting methods yields the highest profit-per-trade. Additionally, by allowing the model to abstain from trading when the predicted magnitude of change is small, profits per trade can be further increased. Our proposed forecasting approach, utilizing a blend of methods, demonstrates superior accuracy compared to individual methods for high-frequency data.

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Pairs trading: is it applicable to exchange-traded funds?

Cited by 6 publications

References 18 publications

An Entropic Approach for Pair Trading in PSX

An Entropic Approach for Pair Trading in PSX

Cointegrated Portfolios and Volatility modeling in the Cryptocurrency Market

Machine Learning-Enhanced Pairs Trading

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