PAIR TRADING STRATEGY IN INDIAN CAPITAL MARKET: Correlation Weight Method(2)

Weight Method(2)

Two series of variables are grouped and tested. Test result signifies that F value is very high compared to Critical F value. Hence the Null hypothesis is rejected at 99% confidence level. So, the means of Pair strategy return and Naive return are statistically different. Trivariate correlation weigh Pair strategy return is much higher than the Naive return, and hence it’s recommended to invest in trivariate correlation weigh pair to cash the arbitrage opportunity.

Consolidating all the results we get:

TYPE OF PAIR RETURN
Natural pairs 386%
Artificial pair with 2 stocks formed using equal weigh method 314%
Artificial pair with 3 stocks formed using equal weight method 268%
Artificial pair with 2 stocks formed using correlation weight method 337%
Artificial pair with 3 stocks formed using correlation weight method 272%

Table.21: consolidated returns

It is clear from the above table that, natural (univariate) pairs have the highest potential for profitability. At a same risk level natural pairs give higher returns. So, this can be used as the arbitrage opportunity to grab the supernormal profit from the market. On the other hand, among the artificial pairs, the correlation weigh method proved to be superior to the equal weigh method in both the cases bivariate and trivariate pairs. Multivariate pair’s risk is also higher than the natural pairs. So, rather than arbitrage options, these can be used as effective hedging tool for the existing exposure in the market by creating suitable pair for the assets.

Representative APR 391%

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