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Pairs Trading Analysis

Pairs Trading Analysis. Global Asset Allocation Spring 2004 The Hemline Theorists. Pairs Trading Analysis. Introduction Developing the Model Results. Introduction. Long/short, market- and industry-neutral strategy Pair selection criteria: same industry mature companies

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Pairs Trading Analysis

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  1. Pairs Trading Analysis Global Asset Allocation Spring 2004 The Hemline Theorists

  2. Pairs Trading Analysis • Introduction • Developing the Model • Results

  3. Introduction • Long/short, market- and industry-neutral strategy • Pair selection criteria: • same industry • mature companies • long trading histories • similar exposure to macro factors • Assume reversion to historical value relationships

  4. Developing the Model • Variable selection • Stock price ratio • Dividend yield ratio • Selecting in-sample period and data frequency • Daily data: 1987-2004

  5. Pairs Trading Analysis: Model Parameters • Variables Switched on or off • Deviation from mean historical ratio required for trade signal • Translation of individual variable trade signals into overall trade signal

  6. Selecting Pairs – Ford and GM GM introduces its "GM10" family of newly redesigned midsize cars. Restores profitability through streamlined operations. Ford announces highest earnings in auto industry history GM announces a restructuring of its North American sales and marketing operations, replacing marketing division-specific organizations with a single sales

  7. Model Demonstration

  8. In-Sample Optimization • Find the model parameters that: • Maximize average annual return on trade days • Trade on at least 10% of total days • Limit maximum drawdown to 15% • Sanity check to ensure model works over time and is currently valid

  9. Model Parameters

  10. In-Sample Results

  11. Out-of-Sample Results

  12. Extending the Model to Other Pairs Eli Lilly & Merck Coca-Cola & Pepsi

  13. Pairs Trading Analysis Questions?

  14. In Sample Optimization

  15. In Sample Optimization

  16. In Sample Optimization

  17. In Sample Optimization

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