Optimal closing of a pair trade with a model containing jumps.

DOI10.1007/S10492-013-0012-8zbMATH Open1289.91154arXiv1004.2947OpenAlexW3098807584WikidataQ59593862 ScholiaQ59593862MaRDI QIDQ375434FDOQ375434

Carl Lindberg, Stig Larsson, Marcus Warfheimer

Publication date: 30 October 2013

Published in: Applications of Mathematics (Search for Journal in Brave)

Abstract: A pair trade is a portfolio consisting of a long position in one asset and a short position in another, and it is a widely applied investment strategy in the financial industry. Recently, Ekstr"om, Lindberg and Tysk studied the problem of optimally closing a pair trading strategy when the difference of the two assets is modelled by an Ornstein-Uhlenbeck process. In this paper we study the same problem, but the model is generalized to also include jumps. More precisely we assume that the above difference is an Ornstein-Uhlenbeck type process, driven by a L'evy process of finite activity. We prove a verification theorem and analyze a numerical method for the associated free boundary problem. We prove rigorous error estimates, which are used to draw some conclusions from numerical simulations.

Full work available at URL: https://arxiv.org/abs/1004.2947

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zbMATH Keywords

error estimatefinite element methodoptimal stoppingpairs tradingOrnstein-Uhlenbeck-type process

Mathematics Subject Classification ID

Numerical methods (including Monte Carlo methods) (91G60) Portfolio theory (91G10) Stopping times; optimal stopping problems; gambling theory (60G40)

Cites Work

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Cited In (8)

• A flexible regime switching model with pairs trading application to the S&P 500 high-frequency stock returns
• Pairs Trading with Opportunity Cost
• On some properties of a trade closure widely used in numerical modelling
• Bertram's pairs trading strategy with bounded risk
• A CLOSED-FORM SOLUTION FOR OPTIMAL ORNSTEIN–UHLENBECK DRIVEN TRADING STRATEGIES
• Pairs trading with a mean-reverting jump–diffusion model on high-frequency data
• Analytic value function for a pairs trading strategy with a Lévy-driven Ornstein–Uhlenbeck process
• PAIRS TRADING UNDER DRIFT UNCERTAINTY AND RISK PENALIZATION

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