Optimal Entry and Exit with Signature in Statistical Arbitrage

TL;DR

This paper develops a signature-based optimal stopping strategy for trading mean-reverting spreads, determining precise entry and exit points to maximize gains without assuming specific spread dynamics.

Contribution

It introduces a novel signature optimal stopping method for flexible, assumption-free timing of trades in mean-reverting markets.

Findings

Outperforms traditional mean reversion trading rules in numerical tests

Provides a flexible framework adaptable to various spread dynamics

Unveils exact entry and exit timings to maximize trading gains

Abstract

In this paper, we explore an optimal timing strategy for the trading of price spreads exhibiting mean-reverting characteristics. A sequential optimal stopping framework is formulated to analyze the optimal timings for both entering and subsequently liquidating positions, all while considering the impact of transaction costs. Then we leverages a refined signature optimal stopping method to resolve this sequential optimal stopping problem, thereby unveiling the precise entry and exit timings that maximize gains. Our framework operates without any predefined assumptions regarding the dynamics of the underlying mean-reverting spreads, offering adaptability to diverse scenarios. Numerical results are provided to demonstrate its superior performance when comparing with conventional mean reversion trading rules.