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Granger causality test in pairs trading
Many traditional pairs trading strategies use cointegration tests for pair selection. If a pair of stocks is found to be cointegrated then this pair is accepted for trading. In this article I will check if using Granger causality test in pair selection process can improve the performance of such strategies. Idea for this article comes…
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Quasi-multivariate pairs trading
This article is based on a paper ‘M of a kind: A Multivariate Approach at Pairs Trading’ (Perlin, 2007). In this paper author proposes using an artificial portfolio of assets to generate trading signals for a particular stock. It is not a pairs trading strategy in a traditional sense because we only trade one asset of…
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Pairs trading with Markov regime switching
In this article I am going to test a pairs trading strategy based on the paper ‘A regime-switching relative value arbitrage rule’ (Bock and Mestel, 2009). It describes how to use Markov regime switching models to identify trading signals in pairs trading strategies. The main reasoning behind this idea is the following. Sometimes historic relationship between two stocks in…
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Pairs trading with copulas
Two previous articles were dedicated to describing the general idea behind copula and different copula families. Now we can apply these ideas to implementing a pairs trading strategy. In this article I am going to implement and backtest a strategy based on paper ‘Trading strategies with copulas’ by Stander at al. (2013). The general algorithm is this:…
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Introduction to copulas (Part 2)
In this article I’m going to describe several more advanced copula functions (compared to the ones described in the previous part). I will consider copulas from Archimedean family — Clayton, Gumbel, Frank and Joe copulas. I will implement them from scratch in Python and show how to sample from them and how to fit them to data. Archimedean family…
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Introduction to copulas (Part 1)
Copula is a method of modeling dependencies between several variables,which is widely used in finance. In this article I will try to describe its basic principles and demonstrate how it works on simple examples. I assume that the reader is familiar with basic probability theory and understands the concepts of probability density functions (PDFs) and cumulative density functions…