Gold Standard Pairs Trading Rules: Are They Valid?

Abstract

Pairs trading is a strategy based on exploiting mean reversion in prices of securities. It has been shown to generate significant excess returns, but its profitability has dropped significantly in recent periods. We employ the most common distance and cointegration methods on US equities from 1990 to 2020 including the Covid-19 crisis. The strategy overall fails to outperform the market benchmark even with hyperparameter tuning, but it performs very strongly during bear markets. Furthermore, we demonstrate that market factors have a strong relationship with the optimal parametrization for the strategy, and adjustments are appropriate for modern market conditions.