PAIR TRADING STRATEGY IN INDIAN CAPITAL MARKET: HYPOTHESIS (Cont.)

 

HYPOTHESIS (Cont.)

Artificial pairs with more than 3 stocks are not considered as the sample of the study, because the transaction cost involved is very high and profit potential reduces accordingly. Moreover it’s been studied that the correlation between the stock and its pair with more than 3 stocks is considerably low and does not give any significant return. So, artificial pairs with more than 3 stocks are excluded from the scope of this study.

Thus a total of possible 445 pairs are formed for analysis of their return in the chosen study period. The analysis has been done separately for
• Natural pairs
• Artificial pair with 2 stocks formed using equal weigh method
• Artificial pair with 3 stocks formed using equal weight method
• Artificial pair with 2 stocks formed using correlation weight method
• Artificial pair with 3 stocks formed using correlation weight method

Nature of Pair No of Pairs
Natural pairs 73
Artificial pair with 2 stocks formed using equal weigh method 101
Artificial pair with 3 stocks formed using equal weight method 85
Artificial pair with 2 stocks formed using correlation weight method 101
Artificial pair with 3 stocks formed using correlation weight method 85
Total No of Pairs 445

Table 1: No. of pairs

Return for each pair is calculated for 9 selected trading signal. This wide array of trading signal gives us the insight about the effect of transaction cost on total no. of trade and its impact on the average return, risk-return behavior of the pair trading strategies etc. The signal for trade opening, square off and spread for all 9 signals are tabulated below:

Trade opening Square off Spread
0.7 or -0.7 0.5 or -0.5 0.2
0.7 or -0.7 0.4 or -0.4 0.3
0.6 or -0.6 0.4 or -0.4 0.2
0.6 or -0.6 0.3 0r -0.3 0.3
0.5 or -0.5 0.3 0r -0.3 0.2
0.5 or -0.5 0.2 or -0.2 0.3
0.4 or -0.4 0.2 or -0.2 0.2
0.4 or -0.4 0.1 or -0.1 0.3
0.3 0r -0.3 0.1 or -0.1 0.3
ei is the unit of measurement

Table 2: Spread and Trade signals

Representative APR 391%

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