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Pairs trading strategies in a cointegration framework: back-tested on CFD and optimized by profit factor

Abstract : Statistical arbitrage is based on pairs trading of mean-reverting returns. We used cointegration approach and ECM-DCC-GARCH to construct 98 pairs of 152 stocks of 3 currencies. Stocks trading is done by Contract for Difference (CFD), a financial derivative product which facilitates short selling and provides a leverage up to 25 times. To measure the performance of a leveraged strategy, we introduced the profit factor which is the annualized return rate per unit risk. And the historical risk is measured by maximum drawdown. We compared three main strategies: percentage, standard deviation of cointegration long-term residuals and Bollinger Bands (dynamic standard deviation), with and without double confirmation of short-term standard deviation modelled by ECM-DCC-GARCH. Each of the three main strategies is optimized by two optimizers: absolute profit and profit factor. The optimization period goes from 2012–01-01 to 2014–12-31, and validation period is from 2015–01-01 to 2016–06-01. Our results showed that the USD Bollinger Bands strategy without double confirmation and optimized by profit factor, outperformed other strategies and provided the highest annualized return rate per unit risk; 32% of our sample pairs ended up in loss, and 94% of which are explained by a cointegration break during the testing period.
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https://halshs.archives-ouvertes.fr/halshs-01970192
Contributor : Anne l'Azou <>
Submitted on : Friday, January 4, 2019 - 5:45:37 PM
Last modification on : Friday, February 7, 2020 - 11:42:01 AM

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Zhe Huang, Franck Martin. Pairs trading strategies in a cointegration framework: back-tested on CFD and optimized by profit factor. Applied Economics, Taylor & Francis (Routledge), 2019, 51 (22), pp.2436-2452. ⟨10.1080/00036846.2018.1545080⟩. ⟨halshs-01970192⟩

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