Pair Trading: Worksheet Download

According to Hedge Fund Research Inc.'s 2002 Industry Report, worldwide hedge funds have grown from $39 billion in assets under management (AUM) in 1990 to more than $622 billion in 2002. The number of funds has increased from roughly 530 in 1990 to more than 4,600 in 2002. Clearly, hedge funds are a rapidly growing industry.

As hedge funds have evolved, so too have the trading strategies employed. In the early 1980s, long/short equity, managed futures and equity hedge were some of the most popular trading strategies employed. The most successful players usually ended-up evolving into global macro funds, e.g. George Soros (Quantum Fund) and Julian Robertson (Tiger Fund). More recently, new strategies such as quantitative credit arbitrage and macro equilibrium models have appeared on the scene, We also note the emergence of fund-of-funds, for which the correct hedge fund strategy mix is of prime importance.

Pair Trading (also known as Pairs Trading) is a popular strategy in the market-neutral-funds sector of hedge funds. It is particularly powerful when markets are volatile and do not show an overall trend. The idea behind pair trading is that two stocks that have shown a high correlation in the past are expected to continue to do so in the near future. Therefore, when the spread between the pair increases, we expect it to diminish after some time. Consequently, for our trading behavior, this implies that when the spread widens we should short the outperformer and buy the underperformer. When the spread decreases, again we should profit from our positions.

This Application Note addresses hedge funds and one of the commonly used strategies known as pair trading. The goal is to show you how to effectively construct an efficient portfolio using Insightful software. Also available is a working example that uses a small sample of stocks and determines the weight of each stock required to obtain specific risk-return characteristics.

• Download the Pair Trading Application Note
• Download the Pair Trading Worksheet and Datasets

Please note Insightful Miner, S+FinMetrics, S+NuOPT and S-PLUS are required to use the Pair Trading Worksheet. Please contact a sales representative for a trial copy of the above software.

Back to general information about implementing trading strategies with Insightful software.