Abstract by Christian Davis
Pairs Trading: Finding the Optimal Value of k
Pairs trading is a stock market arbitrage technique that seeks to profit on market deviations of two correlated stocks. These market deviations are quantified by the number of standard deviations, k, away from the historical ratio of the selected stocks. When the ratio deviates far enough away from its historical average, an opportunity is presented to make money. We will determine a way to find the optimal value of k to maximize profits. Additionally, using Monte Carlo simulation studies, we will evaluate the effect of correlation on finding the optimal k and also determine the effect of correlation on profits. Using the information we gathered from the simulation study, we will assess how our technique performs in a real-world example.