The Study Of Pairs Trading Based On Stochastic Control Model

In recent years,with the popularity of machine learning,artificial intelligence and other technologies,quantitative investment has also become the focus of financial investment.Pairs trading strategy studied in this paper is a classic quantitative investment strategy.Pairs trading was pioneered by Morgan Stanley's quantitative team.Since then,a large number of frontier theories and techniques have been applied to the research of pairs trading.At the same time,the pairs trading strategy has been applied to investment practice by many international hedge funds,and has become a conventional arbitrage trading tool in overseas markets.For a long time,due to the lack of short selling mechanism in domestic market,there are very few research and practice in the domestic market.However,with the introduction of the margin financing and securities lending business,pairs trading became an emerging trading strategy within the A-share market.The demand for research on pairs trading strategies is also very urgent.In this context,this paper proposes a pairs trading strategy based on stochastic control model,and gives an empirical analysis of the A-share market.The key to the traditional pairs trading based on distance or cointegration testing is to determine the opening and closing thresholds.When the dispersion of spreads exceeds the opening threshold,short strong stocks and long short stocks;when the spread returns to a close or stop loss threshold,close the position.The stochastic control method used in this paper provides a new framework for pairs trading.This paper transforms the pairs trading problem into a stochastic optimal control problem and optimizes the weights of the pairs' assets and the risk-free assets in the portfolio.In this paper,the detailed process of establishing a pairs trading model using stochastic control method and the estimation of parameters in the model are given.Subsequently,this paper makes an empirical analysis of this strategy in the CSI 300 Constituent Stocks.At the same time,in order to compare with the traditional method of pairs trading,the empirical results of distance-based paired trading are given.Through empirical analysis of trading strategies,this paper concludes that pairs trading strategy based on stochastic control method is effective in the A-share market.Compared with the CSI 300 index holding strategy,the stochastic pairs trading can obtain an annualized excess return rate of 14.07%.And the strategy's return volatility,Sharpe ratio,maximum drawback and other risk indicators are better than the CSI 300 index.Compared with the traditional distance-based pairs trading strategy,the risk of the stochastic model approach is greater,but the profitability of the strategy is also greatly increased.Overall,the pairs trading strategy based on the stochastic control model is significantly better than the traditional pairs trading strategy.At the same time,unlike the previous literature,this paper finds that there are many pairs trading opportunities for individual stocks in different industries.This paper constructs the new framework of pairs trading,which turns the pairs trading problem into a stochastic control problem.This is completely different from the previous pairs v framework based on statistical methods,it is a totally new attempt.In the empirical analysis,this paper has effectively optimized the theoretical model based on actual data.In a word,this paper presents an innovative pairs trading strategy that is theoretically perfect and feasible in practice.