Large-scale empirical study on pairs trading for all possible pairs of stocks listed on the first section of the Tokyo Stock Exchange

TL;DR

This paper conducts a large-scale empirical analysis of pairs trading on the Tokyo Stock Exchange, demonstrating its effectiveness over three years with positive profit rates across most threshold combinations.

Contribution

It introduces an automated pairs trading strategy based on first-passage process thresholds and validates its effectiveness on a vast dataset of stocks and pairs.

Findings

Pairs trading yields positive profit rates in most cases.

The strategy is effective over a three-year period (2010-2012).

Automated trading based on first-passage thresholds is viable.

Abstract

We carry out a large-scale empirical data analysis to examine the efficiency of the so-called pairs trading. On the basis of relevant three thresholds, namely, starting, profit-taking, and stop-loss for the `first-passage process' of the spread (gap) between two highly-correlated stocks, we construct an effective strategy to make a trade via `active' stock-pairs automatically. The algorithm is applied to $1,784$ stocks listed on the first section of the Tokyo Stock Exchange leading up to totally $1,590,436$ pairs. We are numerically confirmed that the asset management by means of the pairs trading works effectively at least for the past three years (2010-2012) data sets in the sense that the profit rate becomes positive (totally positive arbitrage) in most cases of the possible combinations of thresholds corresponding to `absorbing boundaries' in the literature of first-passage processes.