I demonstrated cointegration, a mathematical test to identify stationary pairs where the spread by definition must be mean reverting. Trading panel cointegration test in stata forex cointegrated pair is straight forward, we know the mean and variance of the spread, we know that those values are constant. The entry point for a stat arb is to simply look how to perform cointegration test in stata forex a large deviation away from the mean.
All the above strategies look to exit their position when the spread has reverted to the mean. Personally I wouldn’t trade any of the above as they don’t specify an exit strategy for adverse trades. Ie if there is a 6 standard deviation move in the spread is this an amazing trade opportunity? OR more likely did the spread just blow up. This post will look at the moving average and rolling standard deviation model for Royal Dutch Shell A vs B shares, it will use the hedge ratio found in the last post. The stat arb has a Superior Sharpe ratio over simply investing in Shell A.
At a first glance the sharpe ratio of 0. 8 looks disappointing, however since the strategy spends most of it’s time out of the market it will have a low annualized sharpe ratio. The short positions should be moneyness ATM or lightly OTM in my opinion. Did you tried using Johansen’s testing approach in order to perform a more rigorous testing of cointegration? What do you think about combining Engle-Granger with Johansen? However for practical purposes as long as the mean reversion happens faster than the mean changes then you’ll do well.
Please note that in the above demo the look back period is 90days. It will most likely increase the size of the standard deviation bands and result in less trades per year. This usually results in a lower Sharpe ratio. Would love to see the implementation on a basket of pairs. I do some changes in your programme to calculate the bollinger bands and I wanna know why you’re put the Standard deviation to the right? EViews offers support for several types of modified augmented Dickey-Panel unit root test with structural break in stata forex tests which allow for levels and trends that differ across a single break date.
You may compute unit root tests with a single break under various specifications for the break. Economics, 1992, University of California, Berkeley. Fixed-effects dynamic panel models, a factor analytical method. Panel Unit Root Tests with Cross-Section Dependence, a further investigation. 2010, Econometric Theory , with S.