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

DOI10.1007/S10492-013-0012-8MaRDI QIDQ375434zbMATH OpenOpenAlexWikidataFDO

Authors Stig Larsson, Carl Lindberg, Marcus Warfheimer

Publication date 30 October 2013

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

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

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)

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.

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Cited in

(8)

• On some properties of a trade closure widely used in numerical modelling
• 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 with opportunity cost
• A flexible regime switching model with pairs trading application to the S\&P 500 high-frequency stock returns
• Pairs trading under drift uncertainty and risk penalization
• Bertram's pairs trading strategy with bounded risk
• A closed-form solution for optimal Ornstein-Uhlenbeck driven trading strategies

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