STATISTICAL ARBITRAGE PAIRS TRADING STRATEGIES: REVIEW AND OUTLOOK

Abstract This survey reviews the growing literature on pairs trading frameworks, i.e., relative‐value arbitrage strategies involving two or more securities. Research is categorized into five groups: The distance approach uses nonparametric distance metrics to identify pairs trading opportunities. The cointegration approach relies on formal cointegration testing to unveil stationary spread time series. The time‐series approach focuses on finding optimal trading rules for mean‐reverting spreads. The stochastic control approach aims at identifying optimal portfolio holdings in the legs of a pairs trade relative to other available securities. The category “other approaches” contains further relevant pairs trading frameworks with only a limited set of supporting literature. Finally, pairs trading profitability is reviewed in the light of market frictions. Drawing from a large set of research consisting of over 100 references, an in‐depth assessment of each approach is performed, ultimately revealing strengths and weaknesses relevant for further research and for implementation.