Pairs Trading: An Implementation of the Kalman Filter on the Swedish Equity Market
(2018) NEKH02 20181Department of Economics
- Abstract
- Pairs trading is a widely known investment strategy among hedge funds and institutional investors that focuses on profiting from the relative mispricing between assets. A vast majority of exisiting pairs trading algorithms rely on rather restrictive assumptions concerning the modeling of the so-called spread function and are unable to capture the effects of changing market conditions into the trading procedure. Hence, this study attempts to optimize the pairs trading strategy by applying a dynamic model that is able to update the parameters of the spread function continuously over time and thereby capture new information coming in from the market. This is accomplished by implementing a Kalman filter on the cointegration approach with data... (More)
- Pairs trading is a widely known investment strategy among hedge funds and institutional investors that focuses on profiting from the relative mispricing between assets. A vast majority of exisiting pairs trading algorithms rely on rather restrictive assumptions concerning the modeling of the so-called spread function and are unable to capture the effects of changing market conditions into the trading procedure. Hence, this study attempts to optimize the pairs trading strategy by applying a dynamic model that is able to update the parameters of the spread function continuously over time and thereby capture new information coming in from the market. This is accomplished by implementing a Kalman filter on the cointegration approach with data from the Swedish equity market. The empirical results suggest that the implemented pairs trading strategy exhibits excess returns of 58.16 % and is superior to the traditional, static model in terms of both return and risk metrics. (Less)
Please use this url to cite or link to this publication:
http://lup.lub.lu.se/student-papers/record/8947454
- author
- Bijelic, Anna LU and Lundholm, Jens
- supervisor
- organization
- course
- NEKH02 20181
- year
- 2018
- type
- M2 - Bachelor Degree
- subject
- keywords
- Pairs trading, statistical arbitrage, Kalman filter, cointegration
- language
- English
- id
- 8947454
- date added to LUP
- 2018-07-05 11:24:47
- date last changed
- 2018-07-05 11:24:47
@misc{8947454, abstract = {{Pairs trading is a widely known investment strategy among hedge funds and institutional investors that focuses on profiting from the relative mispricing between assets. A vast majority of exisiting pairs trading algorithms rely on rather restrictive assumptions concerning the modeling of the so-called spread function and are unable to capture the effects of changing market conditions into the trading procedure. Hence, this study attempts to optimize the pairs trading strategy by applying a dynamic model that is able to update the parameters of the spread function continuously over time and thereby capture new information coming in from the market. This is accomplished by implementing a Kalman filter on the cointegration approach with data from the Swedish equity market. The empirical results suggest that the implemented pairs trading strategy exhibits excess returns of 58.16 % and is superior to the traditional, static model in terms of both return and risk metrics.}}, author = {{Bijelic, Anna and Lundholm, Jens}}, language = {{eng}}, note = {{Student Paper}}, title = {{Pairs Trading: An Implementation of the Kalman Filter on the Swedish Equity Market}}, year = {{2018}}, }