Dynamic pairs trading using the stochastic control approach |
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Authors: | Agnè s Tourin,Raphael Yan |
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Affiliation: | 1. New York University Polytechnic Institute, Department of Finance and Risk Engineering, Room RH519, Six MetroTech Center, Brooklyn, NY 11201, United States;2. BlackRock, Inc., 55 East 52nd Street, New York, NY 10055, United States |
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Abstract: | We propose a model for analyzing dynamic pairs trading strategies using the stochastic control approach. The model is explored in an optimal portfolio setting, where the portfolio consists of a bank account and two co-integrated stocks and the objective is to maximize for a fixed time horizon, the expected terminal utility of wealth. For the exponential utility function, we reduce the problem to a linear parabolic partial differential equation which can be solved in closed form. In particular, we exhibit the optimal positions in the two stocks. |
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Keywords: | 91G80 |
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