Optimal Pairs Trading Strategies

Optimal Pairs Trading Strategies: A Stochastic Mean–Variance Approach

Yu, F. (TU Delft Applied Probability)
Ching, Wai Ki (The University of Hong Kong; Hughes Hall)
Wu, Chufang (The University of Hong Kong; Southern University of Science and Technology)
Gu, Jia Wen (Southern University of Science and Technology)

2022

In this paper, we consider optimal pairs trading strategies in terms of static optimality and dynamic optimality under mean–variance criterion. The spread of the entity pairs is assumed to be mean-reverting and follows an Ornstein–Uhlenbeck process. A constrained optimal control problem is considered, and the Lagrange multiplier technique is adopted to transform the primal problem into a family of linear-quadratic optimal control problems that can be solved by the classical dynamic programming principle. Both solutions for static and dynamic optimal pairs trading problems are derived and discussed. We show that the “static and dynamic optimality” is a viable approach to the time-inconsistent control problem. Furthermore, numerical experiments are presented to demonstrate the performance of the optimal pairs trading strategies.

Dynamic optimality
Mean–variance (MV) analysis
Ornstein–Uhlenbeck (OU)
Pairs trading
Time inconsistency

http://resolver.tudelft.nl/uuid:056b963e-01e8-4a00-8b22-a32e7e57e0df

https://doi.org/10.1007/s10957-022-02131-x

2023-07-01

0022-3239

Journal of Optimization Theory and Applications, 196 (1), 36-55

Green Open Access added to TU Delft Institutional Repository 'You share, we take care!' - Taverne project https://www.openaccess.nl/en/you-share-we-take-care Otherwise as indicated in the copyright section: the publisher is the copyright holder of this work and the author uses the Dutch legislation to make this work public.

Institutional Repository

journal article

© 2022 F. Yu, Wai Ki Ching, Chufang Wu, Jia Wen Gu