Pairs Trading and Stock Returns: An Evidence from Pakistan Stock Exchange

Authors

  • Usman Shaukat Research Scholar, Faculty of Management Sciences International Islamic University, Islamabad
  • Abdul Rehman Dean, Faculty of Management Sciences, International Islamic University Islamabad
  • Ayaz ul Haq Assistant Professor, Islamabad Business School, Affiliated with Quaid e Azam University, Islamabad. Pakistan

Abstract

Market Efficiency Hypothesis includes the strong, semi-strong and weak form of efficiencies that exists in the market. Weak form of efficiency states that future price of the stocks cannot be determined by using past prices in any way. But there exists Arbitrage Pricing Theory which states that profits can be attained by selling over-valued stocks and buying the under-valued stocks. Pairs Trading concept was generated in 1980 by Nanzio Tartaglia. Qazi, Rahman, & Gul, 2015 defined pairs trading as statistical arbitrage approach that short term changes concurrently reflected by two stocks for long-run equilibrium position benefits trader. This research focused on the stock returns of financial and non-financial sector of Pakistan Stock Exchange for a period of seven years from 2009 to 2016 through pairs trading concept and also includes Jensen Alpha model for risk-adjusted returns. Under the distance approach proposed by (Gatev et al., 2006; Bolgun et al., 2010; Kanamura, 2008; Pizzutelo, 2013; Perlin, 2008), pairs are formed using minimum squared distance between pairs and then traded. Evidence has been found regarding the high stock returns ranging upto 18.48% and 27.93% per annum using pairs trading and hypothesis are accepted.

References

Atsalakis, G. S., &Valavanis, K. P. (2009).Surveying stock market forecasting techniques–Part II: Soft computing methods. Expert Systems with Applications, 36(3), 5932-5941.

BolgГјn, K. E., Kurun, E., &GГјven, S. (2010). Dynamic pairs trading strategy for the companies listed in the Istanbul stock exchange. International review of applied financial issues and economics, (1), 37-57.

Campbell, J. Y., & Shiller, R. J. (1987). Cointegration and tests of present value models. Journal of political economy, 95(5), 1062-1088.

Chen, C. W., Wang, Z., Sriboonchitta, S., & Lee, S. (2017). Pair trading based on quantile forecasting of smooth transition GARCH models. The North American Journal of Economics and Finance, 39, 38-55.

Chen, Z., &Knez, P. J. (1995).Measurement of market integration and arbitrage. Review of financial studies, 8(2), 287-325.

Cozier, J. G., & Watson, P. K. (2019). Co-movement in Stock Prices in Emerging Economies: The Case of the Caricom Region. International Economic Journal, 33(1), 111-127.

Deaves, R., Liu, J., &Miu, P. (2013). Pairs trading in Canadian markets: Pay attention to inattention. Canadian Investment Review, Analysis and Research.

Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The journal of Finance, 25(2), 383-417.

Figuerola Ferretti, I., Paraskevopoulos, I., & Tang, T. (2018).Pairs trading and spread persistence in the European stock market. Journal of Futures Markets, 38(9), 998-1023.

Gatev, E., Goetzmann, W. N., &Rouwenhorst, K. G. (2006). Pairs trading: Performance of a relative-value arbitrage rule. Review of Financial Studies, 19(3), 797-827.

Huang, B., Huan, Y., Xu, L. D., Zheng, L., &Zou, Z. (2019). Automated trading systems statistical and machine learning methods and hardware implementation: a survey. Enterprise Information Systems, 13(1), 132-144.

Kanamura, T., Rachev, S. T., &Fabozzi, F. J. (2008). The application of pairs trading to energy futures markets.Technical Reports, Karlsruhe Institute of Technology, 2008.

Krauss, C., &StГјbinger, J. (2017). Non-linear dependence modeling with bivariate copulas: statistical arbitrage pairs trading on the S&P 100. Applied Economics, 1-18.

Lamont, O. A., &Thaler, R. H. (2003). Can the market add and subtract? Mispricing in tech stock carve-outs. Journal of Political Economy, 111(2), 227-268.

Liu, B., Chang, L. B., &Geman, H. (2017). Intraday pairs trading strategies on high frequency data: the case of oil companies. Quantitative Finance, 17(1), 87-100.

Lucey, M. E., &Walshe, D. P. (2011). European Equity Pairs Trading: The Effect of Data Frequency on Risk and Return.

Mori, M., &Ziobrowski, A. J. (2011).Performance of pairs trading strategy in the US REIT market. Real Estate Economics, 39(3), 409-428.

Namwong, N., Yamaka, W., &Tansuchat, R. (2019, January).Trading Signal Analysis with Pairs Trading Strategy in the Stock Exchange of Thailand.In International Conference of the Thailand Econometrics Society (pp. 378-388).

Perlin, M. S. (2009). Evaluation of pairs-trading strategy at the Brazilian financial market. Journal of Derivatives & Hedge Funds, 15(2), 122-136.

Broel-Plater, J., & Nisar, K. (2010). A Wider Perspective on Pairs Trading.

Qazi, L. T., Rahman, A. U., &Gul, S. (2015). Which pairs of stocks should we trade? Selection of pairs for statistical arbitrage and pairs trading in Karachi Stock Exchange. Pakistan Development Review, 54(3), 215.

Rad, H., Low, R. K. Y., & Faff, R. (2016). The profitability of pairs trading strategies: distance, cointegration and copula methods. Quantitative Finance, 16(10), 1541-1558.

Sedighi, M., Jahangirnia, H., & Gharakhani, M. (2019).A New Efficient Metaheuristic Model for Stock Portfolio Management and its Performance Evaluation by Risk-adjusted Methods. Int. J. Financ. Manag. Account, 3, 63-77.

Smith, R. T., &Xu, X. (2017). A good pair: alternative pairs-trading strategies. Financial Markets and Portfolio Management, 1-26.

Downloads

Published

30.06.2021

How to Cite

Shaukat, U., Rehman, A., & Haq, A. ul. (2021). Pairs Trading and Stock Returns: An Evidence from Pakistan Stock Exchange. CITY UNIVERSITY RESEARCH JOURNAL, 11(2). Retrieved from https://cusitjournals.com/index.php/CURJ/article/view/501

Issue

Section

Articles