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Highlights from
Cointegration and Pairs Trading with Econometrics Toolbox

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Cointegration and Pairs Trading with Econometrics Toolbox



Demo files from the webinar of same title.

Intraday Pairs trading

Intraday Pairs trading

This demo shows how functionality within Econometric Toolbox can be used to identify and calibrate a simple, intraday pairs trading strategy.

Copyright 2010-2011, The MathWorks, Inc. All rights reserved.


Load intraday data from a database

We will download intraday data for Brent Crude (LCO) from our database. We will also download data corresponding to West Texas Intermediate (WTI).

LCO = getMinuteDataFromDB('LCO');
WTI = getMinuteDataFromDB('WTI');

pairsChart(LCO, WTI)

% These two time series have historically tracked each other, but since
% December 2010, LCO has consistently traded higher than WTI.  It would
% seem that a pairs trading strategy would not work in 2011, but if we are
% willing to actively recalibrate our model on an intraday basis, we may
% find profitable opportunities.

Let's focus on the last 11 days' of data:

series = [LCO(end-4620+1 : end, 4) WTI(end-4620+1 : end, 4)];

The cointegration test framework

Econometrics Toolbox supports both the Engle-Granger and the Johansen cointegration frameworks. Engle-Granger is the older model, and Johansen is particularly useful for analyzing more than two time series at a time. We will use Engle-Granger for our trading model.

% First, we note that the last 11 days are not cointegrated as a whole
% (A zero indicates failure to reject the null hypothesis that no
% cointegrating relationship exists.)
ans =


Even so, there are smaller windows of time where a cointegrating relationship does exist.

[h, ~, ~, ~, reg1] = egcitest(series(1700:2000, :));
h =


The test estimates the coefficients of the cointegrating regression as well as the residuals and the standard errors of the residuals: all useful information for any pairs trading strategy.

reg1 = 

       num: 301
      size: 301
     names: {2x1 cell}
     coeff: [2x1 double]
        se: [2x1 double]
       Cov: [2x2 double]
    tStats: [1x1 struct]
     FStat: [1x1 struct]
       yMu: 110.7448
    ySigma: 0.3043
      yHat: [301x1 double]
       res: [301x1 double]
    DWStat: 0.1891
       SSR: 13.0123
       SSE: 14.7666
       SST: 27.7789
       MSE: 0.0494
      RMSE: 0.2222
       RSq: 0.4684
      aRSq: 0.4666
        LL: 26.6152
       AIC: -49.2304
       BIC: -41.8162
       HQC: -46.2636

The pairs trading strategy

The following function describes our pairs strategy.

edit pairs

We may test this strategy as we do our other rules:

pairs(series, 420, 60)
% Note that this strategy will not trade if the most recent minutes do not
% show signs of cointegration and that the size of the long/short positions
% are dynamically scaled with the volatility of the cointegrating
% relationship.  Many other customizations can be made.

We can use our existing parameter sweep framework to identify the best combination of calibration window and rebalancing frequency.

if matlabpool('size') == 0
    matlabpool local

window = 120:60:420;
freq   = 10:10:60;
range = {window, freq};

annualScaling = sqrt(250*7*60);
cost = 0.01;

pfun = @(x) pairsFun(x, series, annualScaling, cost);

[~,param] = parameterSweep(pfun,range);

pairs(series, param(1), param(2), 1, annualScaling, cost)
Starting matlabpool using the 'local' configuration ... connected to 8 labs.
Elapsed time is 32.812738 seconds.

Despite the fact that these historically-tracking time series have diverged, we can still create a profitable pairs trading strategy by frequently recalibrating.

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