An Anatomy of Pairs Trading: the role of idiosyncratic news, common information and liquidity
نویسندگان
چکیده
In this paper, we examine the pro tability from a convergence trading strategy called pairs trading which bets that a pair of stocks with price paths that have historically moved together will eventually converge if they ever diverge. We nd that the pro tability from pairs trading is greatest soon after the pairs diverge and that the pro tability is strongly related to events around the date of divergence. Pro tability is low when there is idiosyncratic news about a stock in the pair and high when there is an idiosyncratic liquidity shock to a stock in the pair. When there is information common to both stocks in the pair, we nd that the pro ts to pairs trading can be high when frictions cause this information to be more quickly incorporated into one stock in the pair and not the other. We further show how idiosyncratic news, common information and liquidity are systematically related to horizon risk, divergence risk and the speed of convergence of the pairs trading, which illustrates some subtle trade-o¤s faced by arbitragers when attempting to arbitrage such potential mispricing. (JEL Classi cation: G11, G12, G14) We are grateful to Robert Battalio, Shane Corwin, Tom Cosimano, Zhi Da, Levent Guntay, Tim Loughran, Todd Pulvino, Paul Schultz, Sophie Shive, and several empolyees at Lehman Brothers for helpful discussions and comments. We also thank seminar participants at the University of Notre Dame and the Indiana-Purdue-Notre Dame Joint Conference on Finance for valuable feedback. The Zell Center for Risk Management and the Financial Market and Institution Center provided partial funding for this research. All errors are our own. yCorrespondence: Joseph Engelberg, Finance Area, Kenan Flagler Business School, University of North Carolina at Chapel Hill; Pengjie Gao, Finance Department, Mendoza College of Business, University of Notre Dame; and Ravi Jagannathan, Finance Department, Kellogg School of Management, Northwestern University and NBER. E-mail: joseph_engelberg@kenan-agler.unc.edu, [email protected], and [email protected].
منابع مشابه
Does Disclosure Lead to Lower Informed Trading and Symmetric Order-follow Shocks in the Tehran Stock Exchange?
In financial markets, the symmetry of information and the homogeneous interpretation of information among traders is one of the main conditions for market efficiency, but these conditions are in fact violated. In this paper first; we accurately estimated the dynamic measures of trades stemming from information asymmetry and diverse opinions among investors indices by a hidden Markov model. Ther...
متن کاملIdiosyncratic Risk and Disclosure of Corporate Social Responsibility: Emphasizing the Role of Corporate Governance
In this study, the impact of corporate social responsibility (CSR ) disclosure on idiosyncratic risk has been investigated concerning three stakeholder theory, information asymmetry, and risk management. It also goes further and explores the impact of some corporate governance mechanisms such as ownership structure, board characteristics, and incentive contracts on this relationship. To achieve...
متن کاملEnhancing Automated Trading Engines To Cope With News-Related Liquidity Shocks
Liquidity constitutes one of the main determinants of implicit transaction costs. Deriving optimal execution strategies that minimize transaction costs, automated trading engines need to forecast future liquidity levels. By means of an empirical study we provide evidence that the publication of regulatory corporate disclosures is followed by abnormal liquidity levels. As we do not find abnormal...
متن کاملStrategic Trading, Liquidity and Information Acquisition
We study endogenous liquidity trading in a market with long-lived asymmetric information. We distinguish between public information, tractable information that can be acquired and intractable information that cannot be acquired. Besides information asymmetry and noise, the adverse-selection spread depends on the diffusion of intractable information and on the interest rate. With endogenous liqu...
متن کاملEarnings Announcement Premia: The Role of Asymmetric Liquidity Provision
This study examines the link between earnings announcement premia (i.e., higher returns in announcement periods) and changes in liquidity prior to the announcements. Motivated by prior research, we model market makers as holding positive inventories and show they asymmetrically raise costs of providing liquidity to sellers, relative to buyers, to reduce inventory risks ahead of earnings news. T...
متن کامل