Selecting Tradeable Pairs: Which Mensurate To Use?

A invitee weblog past times Paul Farrington

One of the close of import factors inward statistical arbitrage pairs trading is the choice of the paired instruments.  We tin role basic heuristics to direct us, such equally grouping stocks past times manufacture inward the anticipation that stocks alongside like key characteristics volition part element run a peril together with tend to present co-movement.  But this even thus leaves us alongside potentially thousands of combinations.  There are to a greater extent than or less statistical techniques nosotros tin role to quantify the tradeability of a pair: 1 approach is to calculate the correlation coefficient of each pair's provide series. Another is to regard cointegration measures on the ratio of the prices, to run across if it remains stationary over time.

In this article I briefly summarise the option approaches together with employ them to a universe of stock pairs inward the petroleum together with gas industry.  To stair out how effective each stair out is inward existent globe trading, I dorsum exam the pairs using a uncomplicated agency reversion system, thus regress the generated win charge per unit of measurement against the statistical results.  Some basic insights emerge equally to the effectiveness of correlation together with cointegration equally tools for selecting candidate pairs.

Please view http://www.paulfarrington.com/research/Selecting%20tradeable%20pairs.htm for details of my methodology together with results.