[IEEE 2008 American Control Conference (ACC '08) - Seattle, WA (2008.06.11-2008.06.13)] 2008 American Control Conference - Optimal pairs trading: A stochastic control approach

✍ Scribed by Mudchanatongsuk, Supakorn; Primbs, James A.; Wong, Wilfred

• Book ID: 125494397
• Publisher: IEEE
• Year: 2008
• Weight: 196 KB
• Category: Article
• ISBN: 1424420784
• DOI: 10.1109/ACC.2008.4586628

✦ Synopsis

In this paper, we propose a stochastic control approach to the problem of pairs trading. We model the logrelationship between a pair of stock prices as an Ornstein-Uhlenbeck process and use this to formulate a portfolio optimization based stochastic control problem. We are able to obtain the optimal solution to this control problem in closed form via the corresponding Hamilton-Jacobi-Bellman equation. We also provide closed form maximum-likelihood estimation values for the parameters in the model. The approach is illustrated with a numerical example involving simulated data for a pair of stocks.