Efficiency of Pairs Trading Strategy by Using Cointegration Approach

A Case Study of SET50

Abstract

This study applies cointegration test to identify stocks in order to use in pairs trading strategy. Sharpe ratio measurement is assessed with the data from stocks in SET50 index of Thailand Stock Exchange starting from January 1st, 2017 to December 30th, 2021. Daily adjusted closing prices are obtained from Yahoo Finance. The data is divided into 8 datasets. Each dataset started 6 months apart and each dataset is divided into training period (12 months) and testing period (6 months). In this study, the pairs were first identified by conintegration approach during a period of 12 months. During this period, the adjusted closing price series were constructed. Then, a cointegration procedure was applied to these series. After that, these pairs were used in the next period of six months.The results show that the pairs trading strategy based on cointegration is able to make profits. While Sharpe ratio of this strategy is outperformed the SET50 index during the study period of 2017-2021.