High-Frequency Equity Pairs Trading: <i>Transaction Costs, Speed of Execution, and Patterns in Returns</i>

Abstract

This article examines the characteristics of high-frequency pairs trading using a sample of FTSE100 constituent stocks for the period January to December 2007. The authors show that the excess returns of the strategy are extremely sensitive both to transaction costs and speed of execution. When we specify a moderate level of transaction costs (15 basis points), the excess returns of the strategy are reduced by more than 50%. Likewise, when a wait-one-period restriction on execution is implemented, the returns of the strategy are eliminated. When the time series properties of pairs trading returns are further examined, it is seen that the majority of returns occur in the first hour of trading. Finally, the authors find that the excess returns bear little exposure to traditional risk factors but are weakly related to market and reversal risk factors. <b>TOPICS:</b>Risk management, financial crises and financial market history, statistical methods