Original Research

Trading strategies with copulas

Yolanda Stander, Daniël Marais, Ilse Botha
Journal of Economic and Financial Sciences | Vol 6, No 1 | a278 | DOI: https://doi.org/10.4102/jef.v6i1.278 | © 2018 Yolanda Stander, Daniël Marais, Ilse Botha | This work is licensed under CC Attribution 4.0
Submitted: 27 June 2018 | Published: 30 April 2013

About the author(s)

Yolanda Stander, Faculty of Economics and Financial Sciences, University of Johannesburg, South Africa
Daniël Marais, Department of Economics and Econometrics, University of Johannesburg, South Africa
Ilse Botha, Department of Finance and Investment Management, University of Johannesburg, South Africa

Full Text:

PDF (671KB)

Abstract

A new approach is proposed to identify trading opportunities in the equity market by using the information contained in the bivariate dependence structure of two equities. The relationships between the equity pairs are modelled with bivariate copulas and the fitted copula structures are utilised to identify the trading opportunities. Two trading strategies are considered that take advantage of the relative mispricing between a pair of correlated stocks and involve taking a position on the stocks when they diverge from their historical relationship. The position is then reversed when the two stocks revert to their historical relationship. Only stock-pairs with relatively high correlations are considered. The dependence structures of the chosen stock-pairs very often exhibited both upper- and lower-tail dependence, which implies that copulas with the correct characteristics should be more effective than the more traditional approaches typically applied. To identify trading opportunities, the conditional copula functions are used to derive confidence intervals for the two stocks. It is shown that the number of trading opportunities is highly dependent on the confidence level and it is argued that the chosen confidence level should take the strength of the dependence between the two stocks into account. The backtest results of the pairs-trading strategy are disappointing in that even though the strategy leads to profits in most cases, the profits are largely consumed by the trading costs. The second trading strategy entails using single stock futures and it is shown to have more potential as a statistical arbitrage approach to construct a portfolio.

Keywords

copulas; pairs-trading; single stock futures; mean reversion; stock price drift; trading costs; backtest; hedge funds; statistical arbitrage

Metrics

Total abstract views: 3331
Total article views: 2692

 

Crossref Citations

1. Copula-based trading of cointegrated cryptocurrency Pairs
Masood Tadi, Jiří Witzany
Financial Innovation  vol: 11  issue: 1  year: 2025  
doi: 10.1186/s40854-024-00702-7

2. Copula‐Based Pairs Trading on Brazilian Stock Exchange Equities
Daniel Henrique Salgado, Osvaldo Candido
Applied Stochastic Models in Business and Industry  vol: 41  issue: 6  year: 2025  
doi: 10.1002/asmb.70049

3. Optimal Mean-Reverting Portfolio With Leverage Constraint for Statistical Arbitrage in Finance
Ziping Zhao, Rui Zhou, Daniel P. Palomar
IEEE Transactions on Signal Processing  vol: 67  issue: 7  first page: 1681  year: 2019  
doi: 10.1109/TSP.2019.2893862

4. Improving statistical arbitrage investment strategy: Evidence from Latin American stock markets
Fernando Caneo, Werner Kristjanpoller
International Journal of Finance & Economics  vol: 26  issue: 3  first page: 4424  year: 2021  
doi: 10.1002/ijfe.2023

5. Performance of Pairs Trading Strategies Based on Various Copula Methods
Yufei Sun
Journal of Risk and Financial Management  vol: 18  issue: 9  first page: 506  year: 2025  
doi: 10.3390/jrfm18090506

6. STATISTICAL ARBITRAGE PAIRS TRADING STRATEGIES: REVIEW AND OUTLOOK
Christopher Krauss
Journal of Economic Surveys  vol: 31  issue: 2  first page: 513  year: 2017  
doi: 10.1111/joes.12153

7. Pairs Trading with Copulas
Wenjun Xie, Rong Qi Liew, Yuan Wu, Xi Zou
The Journal of Trading  year: 2016  
doi: 10.3905/jot.2016.2016.1.048

8. Non-linear dependence modelling with bivariate copulas: statistical arbitrage pairs trading on the S&P 100
Christopher Krauss, Johannes Stübinger
Applied Economics  vol: 49  issue: 52  first page: 5352  year: 2017  
doi: 10.1080/00036846.2017.1305097

9. Copula-based deviation measure of cointegrated financial assets
А.О. Шульженко
Modern Economy Success  issue: 2  first page: 84  year: 2024  
doi: 10.58224/2500-3747-2024-2-84-92

10. The Optimal Threshold Selection for High-Frequency Pairs Trading via Supervised Machine Learning Algorithms
Mahmut Bağcı, Pınar Kaya Soylu
Computational Economics  year: 2025  
doi: 10.1007/s10614-025-10958-5

11. Pairs Trading with Copulas
Wenjun Xie, Rong Qi Liew, Yuan Wu, Xi Zou
The Journal of Trading  vol: 11  issue: 3  first page: 41  year: 2016  
doi: 10.3905/jot.2016.11.3.041

12. The profitability of pair trading strategy in stock markets: Evidence from Toronto stock exchange
GholamReza Keshavarz Haddad, Hassan Talebi
International Journal of Finance & Economics  vol: 28  issue: 1  first page: 193  year: 2023  
doi: 10.1002/ijfe.2415

13. Pairs Trading in the German Stock Market: Is There Still Life in the Old Dog?
Sascha Wilkens
SSRN Electronic Journal  year: 2024  
doi: 10.2139/ssrn.4807915

14. Statistical arbitrage with vine copulas
Johannes Stübinger, Benedikt Mangold, Christopher Krauss
Quantitative Finance  vol: 18  issue: 11  first page: 1831  year: 2018  
doi: 10.1080/14697688.2018.1438642

15. Improving Cointegration-Based Pairs Trading Strategy with Asymptotic Analyses and Convergence Rate Filters
Yen-Wu Ti, Tian-Shyr Dai, Kuan-Lun Wang, Hao-Han Chang, You-Jia Sun
Computational Economics  vol: 64  issue: 5  first page: 2717  year: 2024  
doi: 10.1007/s10614-023-10539-4

16. Nonlinear relationships in soybean commodities Pairs trading-test by deep reinforcement learning
Jianhe Liu, Luze Lu, Xiangyu Zong, Baao Xie
Finance Research Letters  vol: 58  first page: 104477  year: 2023  
doi: 10.1016/j.frl.2023.104477

17. Pairs trading in the German stock market: is there still life in the old dog?
Sascha Wilkens
Financial Markets and Portfolio Management  vol: 39  issue: 2  first page: 259  year: 2025  
doi: 10.1007/s11408-025-00467-8

18. A Cooperative Dynamic Approach to Pairs Trading
J. P. Ramos-Requena, M. N. López-García, M. A. Sánchez-Granero, J. E. Trinidad-Segovia, Paulo Jorge Silveira Ferreira
Complexity  vol: 2021  issue: 1  year: 2021  
doi: 10.1155/2021/7152846