Review of Financial Studies · 2006 · 809 citations · 26 references
BusinessEconomicsFinanceAsset PricingFinancial EconomicsFinancial MarketsCapital MarketsInvestmentMarket RiskMatching TheoryRisk-return AnalysisTrading StrategiesExcess ProfitsMinimum DistanceRelative Value TradingReturn-risk Trade-off AnalysisRisk-return Tradeoff AnalysisTransaction Cost Economies
The study links pairs trading profitability to a common factor in returns distinct from conventional risk measures. Pairs trading is tested using daily data from 1962–2002 by matching stocks into pairs based on minimal distance between normalized historical prices. The strategy yields up to 11% annualized excess returns, surpassing transaction‑cost estimates, and robustness tests indicate profits arise from temporary mispricing of close substitutes rather than reversal effects.
We test a Wall Street investment strategy, "pairs trading," with daily data over 1962–2002. Stocks are matched into pairs with minimum distance between normalized historical prices. A simple trading rule yields average annualized excess returns of up to 11% for self-financing portfolios of pairs. The profits typically exceed conservative transaction-cost estimates. Bootstrap results suggest that the "pairs" effect differs from previously documented reversal profits. Robustness of the excess returns indicates that pairs trading profits from temporary mispricing of close substitutes. We link the profitability to the presence of a common factor in the returns, different from conventional risk measures.
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On Persistence in Mutual Fund Performance
Mark M. Carhart · The Journal of Finance · 1997 · 17K citations · Full text
Multifactor Explanations of Asset Pricing Anomalies
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On Persistence in Mutual Fund Performance
Mark M. Carhart · The Journal of Finance · 1997 · 3.1K citations