Main Pairs Trading: Quantitative Methods and Analysis Pairs Trading: Quantitative Methods and Analysis Ganapathy Vidyamurthy Comprised of three information-packed parts, Pairs Trading presents an in-depth look at the various aspects of these strategies and provides quantitative tools to assist in their analysis. The first part of this comprehensive resource sets the context for the rest of the book by introducing preliminary material on some key topics, including time series, factor models, and Kalman filtering. After presenting the broad ideas and concepts of this trading method, Pairs Trading delves into two different versions of pairs trading in the equity markets--statistical arbitrage pairs trading and risk arbitrage. Part II of this book details statistical arbitrage pairs trading, which is a relative value arbitrage on two securities based on the premise that there is a long-run equilibrium between the prices of the stocks comprising the pair.
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Chapter 1. Market Neutral Strategy. Pairs Trading. Chapter 2. Time Series. Time Series Models. Goodness of Fit versus Bias. Model Choice. Modeling Stock Prices. Chapter 3. Factor Models. Arbitrage Pricing Theory. The Covariance Matrix. Application: Calculating the Risk on a Portfolio. Application: Calculation of Portfolio Beta. Application: Tracking Basket Design. Sensitivity Analysis. Chapter 4. Kalman Filtering.
The Kalman Filter. The Scalar Kalman Filter. Filtering the Random Walk. Chapter 5. Applying the Model. A Trading Strategy. Road Map for Strategy Design. Chapter 6. Pairs Selection in Equity Markets. Common Trends Cointegration Model. The Distance Measure. Interpreting the Distance Measure. Reconciling Theory and Practice. Chapter 7. Testing for Tradability. The Linear Relationship. Testing Residual for Tradability. Chapter 8.
Trading Design. Band Design for White Noise. Spread Dynamics. Nonparametric Approach. Tying Up Loose Ends. Chapter 9. Risk Arbitrage Mechanics. The Deal Process. Transaction Terms. The Deal Spread. Trading Strategy. Quantitative Aspects. Chapter Trade Execution. Specifying the Order. Verifying the Execution. Execution During the Pricing Period.
Short Selling. The Market Implied Merger Probability. Implied Probabilities and Arrow-Debreu Theory. The Single-Step Model. The Multistep Model. Risk Management. Spread Inversion. The Prediction Equation. The Observation Equation. Applying the Kalman Filter. Model Selection. Applications to Trading. Series Volume Number.
Pairs Trading: Quantitative Methods and Analysis
A pairs trade is a trading strategy that involves matching a long position with a short position in two stocks with a high correlation. The concept uses statistical and technical analysis to seek out potential market-neutral profits. Market-Neutral Arbitrage Market-neutral strategies are a key aspect of pairs of trade transactions. Market-neutral strategies involve long and short positions in two different securities with a positive correlation. The two offsetting positions form the basis for a hedging strategy that seeks to benefit from either a positive or negative trend. Pairs Trade Strategy A pairs trade strategy is based on the historical correlation of two securities. A pairs trade strategy is best deployed when a trader identifies a correlation discrepancy.