Optimal Pairs Trading with Time-Varying Volatility
Optimization and Control
2021-11-05 v1 Numerical Analysis
Numerical Analysis
Probability
Portfolio Management
Abstract
We propose a pairs trading model that incorporates a time-varying volatility of the Constant Elasticity of Variance type. Our approach is based on stochastic control techniques; given a fixed time horizon and a portfolio of two co-integrated assets, we define the trading strategies as the portfolio weights maximizing the expected power utility from terminal wealth. We compute the optimal pairs strategies by using a Finite Difference method. Finally, we illustrate our results by conducting tests on historical market data at daily frequency. The parameters are estimated by the Generalized Method of Moments.
Cite
@article{arxiv.2111.02834,
title = {Optimal Pairs Trading with Time-Varying Volatility},
author = {T. N. Li and A. Tourin},
journal= {arXiv preprint arXiv:2111.02834},
year = {2021}
}