Performance of Pairs Trading Strategy in the U.S. REIT Market

Abstract

We examine the performance of pairs trading in the U.S. REIT market compared with that in the U.S. general stock market over the period 1987 to 2008. The results suggest that the REIT market provided superior profit opportunities for this strategy over common stocks after accounting for the effect of the bidask bounce between 1993 and 2000. This was likely because of the unique characteristics of REITs, which permitted the selection of good pairs of close substitutes and the structural changes that occurred in 1993 in the REIT market. The superior trading profits in REITs disappear after 2000.Pairs trading has been one of the most popular quantitative arbitrage strategies used by hedge fund managers on Wall Street. First implemented by Nunzio Tartaglia's quant group at Morgan Stanley in the mid-1980s (Vidyamurthy 2004), the basic idea behind pairs trading is to find two stocks whose prices have historically moved together and, when the spread between them widens, short the winner and buy the loser. The expectation is that the prices of the two stocks will again converge and the investor will profit by unwinding the positions. Several academic studies propose frameworks to implement pairs trading rather than provide empirical evidence of the effectiveness of pairs trading. Vidyamurthy (2004) explains the link between pricing theory and pairs trading providing an implementation strategy based on cointegration. Elliott, van der Hoek and Malcolm (2005) propose an analytical framework for pairs trading applying a mean-reverting Gaussian Markov chain model. Huck (2009) applies multicriteria decision techniques for the selection of pairs for pairs trading. Regardless of its popularity on Wall Street, only a few studies empirically examine the effectiveness of pairs trading mainly due to the proprietary nature of the strategy. Recently, Gatev, Goetzmann and Rouwenhorst (2006) found that using daily historical price information, pairs trading produced significant profits between 1962 and 2002 in the U.S. stock market, which were robust to conservative estimates of transaction costs and were different from profits achievable from a typical contrarian strategy of buying losers and

Is pairs trading profitable on China AH-share markets?

“…Using daily data on US market from 1963 to 2002, Gatev et al (2006) report average annualized excess returns of 11% from pairs trading, which typically exceed conservative estimates of transaction costs. A recent study by Mori and Ziobrowski (2011) finds that pairs trading is also profitable in the US REIT market. Do and Faff (2012) further examine the impact of trading costs on the performance of pairs trading and find that pairs trading remains profitable after controlling for commissions, market impact and short-selling fees.…”

Pairs trading and selection methods: is cointegration superior?

“…) The most popular reference in the first category is Gatev et al (1999Gatev et al ( , 2006. It also includes Papadakis and Wisocky (2008) and Engelberg et al (2009), Faff (2010, 2012), Jacobs and Weber (2011), Mori and Ziobrowski (2011), Broussard and Vaihekoski (2012) and Huck (2013). These papers explore different dimensions and implications of pairs trading strategies: accounting information, news, liquidity, sensitivity, transaction costs, etc.…”

Which Pairs of Stocks should we Trade? Selection of Pairs for Statistical Arbitrage and Pairs Trading in Karachi Stock Exchange

“…it is profitable in the bearish markets. Mori and Ziobrowski (2011) further asserted that only the market trends are not important for explaining divergence patterns and the profitability of pairs trading rather the market characteristics and dynamics also play a significant role. Do and Faff (2012) once again tested the pairs trading strategy proposed by Gatev, et al (2006) while assessing the impact of transaction cost on the profitability of pairs trading strategy.…”