PAIR TRADING STRATEGY IN INDIAN CAPITAL MARKET: Findings

The research finds that the pair trading strategy is capable of giving good return when invested in an informed way. The multivariate approach studied reveals that, while natural pairs are good for arbitrage opportunities, multivariate pairs can be used as effective hedging tool to hedge existing exposure. All the findings are consolidated and listed below:

• The return from the pair trading strategy is much higher than the return from naive investment. All the pairs studied (natural and multivariate) are able to beat the return of an unskilled investor in the capital market by a huge margin.

• Investment in pair trading strategy requires significant understanding of the pair behavior. Investor has to be flexible in terms of trading signal. For different kind of pairs different trading signal is proved to be good. Investors have to be careful in selecting the spread and to explore the maximum opportunity in the market.

• All the Pair trading strategies follow the conventional risk-return characteristics. So, return depends on the investor’s risk appetite.

• Natural pairs are easily available in the Indian capital market across the industries. Investment in natural pairs is least risky and generates maximum return. So risk-return pay off is highest in case of natural pairs. Hence natural pair investment can be considered as the arbitrage opportunity in the market.

• On the other hand although the multivariate pairs are able to beat the naive return in the market by a huge margin, their return is lesser than the natural pair.

• In multivariate pairs, out of two methods used to assign weight to the constituent stocks of the pair, correlation weigh method is proved to be better than the equal weight method.

CONCLUSION

Finding natural pairs and using two versions of a linear framework in the multivariate approach, the main evidence of this study is that the trading rules from the univariate and multivariate pairs trading strategy had a respectable performance when applied to the Indian Equity market. The evidence of positive excessive return was found at different values of the threshold parameter, showing consistency of the performance. The returns from the eligible pairs are tested for their consistency threshold limit wise and the test results show extreme consistency at a significant confidence interval. The results found at this study motivate the application of such quantitative formulation to other industries in order to check if such positive results can be replicated in a different database.

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