"04-2122_Trading_Strategies_lect

"04-2122_Trading_Strategies_lect - Advanced Investment...

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Click to edit Master subtitle style  1 Advanced Investment Strategies
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 2 What is Pairs Trading? Pairs trading is one type of convergence trade § It identifies two stocks such that the historical prices move together (or, should move together) § If the stock’s prices diverge, pairs trading bets such diversion is temporary and eventually will reverse § By simultaneous longing the relatively “cheap” stocks and shorting relatively “expensive” stocks, pairs trading attempts to capture the L/S spreads Many forms of pairs trading based on the construction of pairs § Froot and Dabora (1999): Siamese twins shares § Getav, Goetzmann and Rouwenhorst (2006, hereafter GGR): 2
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 3 Pair Trading Based on Normalized Prices Two Step Procedure to Implement GGR’s algorithm § Estimation Stage ü Compute the differences between normalized stock prices over one-year horizons ü Identify pairs with the smallest normalized price differences as potential trading candidates § Implementation Stage
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This note was uploaded on 04/09/2011 for the course MGMT 411 taught by Professor Clarke during the Winter '09 term at Purdue.

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"04-2122_Trading_Strategies_lect - Advanced Investment...

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