Sensitivity of Profitability in Cointegration-Based Pairs Trading

Brunetti MariannaDe Luca Roberta
CEIS Research Paper
The cointegrated-based pair trading crucially depends on two key parameters: the length of the formation period and the divergence signal (or opening trigger), which are generally arbitrarily or statistically determined in the literature. In this article, we perform a sensitivity analysis of the pairs trading profitability to its parametrization, employing the daily closing prices of the S&P 500 constituent stocks. We found that that not only the measures of performance (i.e. average excess returns, Sharpe ratios and percentage of positive excess returns), but also strategy characteristics and trades features (i.e. average trades’ duration and number of trades) are highly sensitive to the choice of the parameters.

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Number: 540
Keywords: pairs trading, sensitivity analysis, formation period
JEL codes: G10,G12,C44,C55
Volume: 20
Issue: 4
Date: Monday, April 11, 2022
Revision Date: Monday, April 11, 2022