PAIR TRADING STRATEGY IN INDIAN CAPITAL MARKET: Artificial Pair(1)

Artificial Pair

All the 85 trivariate pairs with equal weigh are not found feasible for trading. Cut off correlation is derived for this segment, which is shown graphically below. The cut off correlation value is 0.67. For further analysis the pairs with correlation above 0.67 are only considered as they follow conventional risk-return relationship. 60 such pairs are found in this segment.

For these 60 pairs individual sample 2-tail t-test is done for each trading signal to check the statistical significance of the obtained returns. The test result includes mean return for each signal, standard deviation of each signal set, and t statistics. The test result is shown below:

One-Sample Statistics
N Mean Std. Deviation Std. Error Mean
0.7/0.5 60 2.649 2.272 0.293
0.7/0.4 60 3.942 6.120 0.790
0.6/0.4 60 2.963 2.436 0.314
0.6/0.3 60 2.660 1.660 0.214
0.5/0.3 60 3.932 6.090 0.786
0.5/0.2 60 2.333 1.809 0.233
0.4/0.2 60 1.841 1.892 0.244
0.4/0.1 60 2.335 5.730 0.740
0.3/0.1 60 1.433 1.293 0.167

Table 11: Mean test result: trivariate pars: equal

One-Sample Test
Test Value = 0
t df Sig. (2-tailed) MeanDifference 95% Confidence Interval of the Difference
Lower Upper
0.7/0.5 9.030 59 1.02E-12 2.649 2.062 3.236
0.7/0.4 4.989 59 5.67E-06 3.942 2.361 5.522
0.6/0.4 9.421 59 2.29E-13 2.963 2.334 3.592
0.6/0.3 12.409 59 4.33E-18 2.660 2.231 3.089
0.5/0.3 5.002 59 5.41E-06 3.932 2.359 5.505
0.5/0.2 9.993 59 2.64E-14 2.333 1.866 2.800
0.4/0.2 7.536 59 3.34E-10 1.841 1.352 2.329
0.4/0.1 3.157 59 0.002513 2.335 0.855 3.815
0.3/0.1 8.589 59 5.57E-12 1.433 1.099 1.767

Table 12.

For 59 degree of freedom t critical value (2 tailed) at 95% confidence level is 2.000. In the test result all the obtained t values are greater than the critical value, which suggests that the return series of every trade signal are statistically significant at 95% confidence level. In other words, it suggests that the average returns are feasible and reproducible in the future following the same trade signal.

This trivariate equal weigh pair trading strategy return is statistically compared with the naive approach return. For the purpose the average of all signal return of every eligible pair is compared with the 1000 random simulation return from the NSE Index in the same time frame of the study. One way ANOVA testing has been done for mean comparison.

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