StudentShare solutions
Triangle menu

Pairs Trading And Strategies And The CAPM - Dissertation Example

Not dowloaded yet

Extract of sample
Pairs Trading And Strategies And The CAPM

Besides testing a model, this study will also be testing market efficiency and using use Cointegration as a decision rule for pair selection, try to ascertain whether different and more efficient rules may be implemented. In order to calculate asset returns we need the Capital Asset Pricing Model (CAPM) which gives predictions on how to measure risk and the relationship between risk and return. The relationship of expected return is linear and is necessary to explain differences in returns among securities. Introduction Pairs trading include tested methods used to identify and invest in pairs. This was developed by Morgan Stanley in the 1980’s and is today one of the most commonly used strategies in the finance and trading industry. Using this strategy, an investor looks at two assets, whose prices have moved together in the past. As the price spread widens, the investor takes a short position in the outperforming asset and a long position in the underperforming asset hoping that the spread will move back again, thereby generating profits. If history then repeats itself, prices will congregate and the arbitrageur will earn revenue. For example, if the U.S. equity markets were efficient at all times, risk-adjusted returns from pairs trading would never be positive. The Morgan Stanley group disbanded in 1989 after a couple of bad years of performance, pairs trading has since then become an progressively more well known market-neutral investment strategy used by investors as well as hedge funds. The increased popularity of quantitative based statistical arbitrage strategies has also been affecting the profits. The Capital Asset Pricing Model (CAPM) is a vital area of financial management that has contributed to finance becoming a scientific and fully fledged discipline of study. There abounds criticism that the Capital Asset Pricing Model is somewhat unrealistic due to the assumptions that it is based upon. This includes the assumption that investors would only require returns on the systematic risking of their portfolios, due to the removal of the unsystematic risk which can hence be ignored. The market neutral portfolios are constructed using just two securities, consisting of a long position in one and a short position in the other, in a predetermined ratio. The two versions of pairs trading in the equity markets are statistical arbitrage pairs and risk arbitrage pairs. A Statistical arbitrage pair trading is based on the idea of relative pricing. The underlying premise in relative pricing is that stocks with similar characteristics must be priced more or less the same. The spread in the case may be thought of as a degree of mutual mispricing, so the greater the spread, the higher the magnitude of mispricing and hence a greater scope of profit. The strategy involves assuming a long-short position when the spread is substantially away from the mean. It is expected that the mispricing will be correct. The position is then reversed and profits are made when the spread reverts. The pairs trading strategy might be justified within an equilibrium asset-pricing framework with non-stationary common factors as noted in Fund & Hsieh (1999). Asset returns can be computed by Capital Asset Pri ...Show more

Summary

PAIRS TRADING AND STRATEGIES AND THE CAPM Name Banking and finance 23 June 2012 Abstract Pairs trading is a trading strategy used to exploit markets that are out of equilibrium, assuming that overtime they will move to rational equilibrium…
Author : adrienne61
Pairs Trading And Strategies And The CAPM essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the dissertation on your topic
"Pairs Trading And Strategies And The CAPM"
with a personal 20% discount.
Grab the best paper

Related Essays

Mechanism of trade dispute settlement in the light of international trading system
The main focus of this research pertains to the WTO dispute settlement mechanisms among nations. This sort of research is important in order to assess and analyse the various dispute settlement mechanisms available to member nations, involved in disputes.
57 pages (14250 words) Dissertation
Commodity Trading in the United Kingdom
This research study examines how two of the largest commodity traders in the world, Vitol and Glencore International, conduct their commodity trading activities through the commodity exchanges in the United Kingdom and in its OTC market.
52 pages (13000 words) Dissertation
Marketing the TV product: operations and strategies
When operating in an environment which is characterised by intense competition, for a marketer to be successful in this kind of industry he needs to design an efficient and effective marketing strategy that is focused on customers. This marketing strategy should be built around the viewers basic motivations.
40 pages (10000 words) Dissertation
Strategic Management: The Alignment of HR Strategies With Corporate Strategies
A mixed methods case study was conducted with which interviews and survey questionnaires were carried out in order to obtain more detailed and comprehensive results. Running records such as company reports and exit interviews were also examined. Findings indicated that the HR strategies of the CMG only focused on administrative functions (e.g.
80 pages (20000 words) Dissertation
Growth strategies in small businesses
Many business organisations, including small and medium- sized enterprises (SMEs), have started to adopt business process digitalisation (hereafter "BPD") as a strategy to grow and to gain market and operational efficiency (Johnston, Wade & McClean, 2007, 360).
1 pages (250 words) Dissertation
What is the EU a trading area or an enlarged European State Should Turkey allowed to join the club
Ever since the foundation of modern day Turkey in 1923, this country with a predominantly Muslim population has been a secular democracy closely aligned with the West.Turkey was a founding member of the United Nations, and has been a member of NATO since 1952, the Council of Europe since 1949, the Organisation for Economic Cooperation and Development (OECD) since 1961 and an associate member of the Western European Union since 1992
35 pages (8750 words) Dissertation
Evacuation Procuedures & Strategies in Buildings
It took sky scrapers around four to five decades to prove themselves a worthy trend in the residential as well as corporate sectors and once the trend was established, it did not take long at all for the skylines of major cosmopolitan cities to be pierced by tall buildings.
32 pages (8000 words) Dissertation
Mechanism Of Trade Dispute Settlement In The Light Of International Trading System
With the onset of globalization, the world has steadily drifted towards an integrated international market. The result is an unprecedented increase in international trade. For some economists this development is both crucial and imperative in the universal pursuit for prosperity and the age-old quest for human development.
3 pages (750 words) Dissertation
Evaluation of the Capital Asset Pricing Model (CAPM) Using Chinese Stock Market Data
Since the introduction of the Capital Asset Pricing Model (CAPM), a series of different efforts have been demonstrated towards evaluating the validity of the model. These evaluation and analyses have been a unique breakthrough and a significant contribution to the finance economics globally (Vialar, 2009; Pg.
42 pages (10500 words) Dissertation
Evaluation of CAPM using American stock market data
The CAPM was built on the model of choice of portfolio developed by Harry Markowitz (1959). According to the model of Markowitz, an investor opts to select a portfolio at time t-1 which would generate a stochastic return at time t. The model assumes that investors are generally risk averse, and at the time of choosing their portfolio they are concerned only about the mean and variance of their return at the end of the period of investment.
12 pages (3000 words) Dissertation
Get a custom paper written
by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
YOUR PRIZE:
Apply my DISCOUNT
Comments (0)
Rate this paper:
Thank you! Your comment has been sent and will be posted after moderation