Pairs Trading: Evaluation of profitability and risks on the Swedish stock market

Sammanfattning: The turbulent market environment experienced over the last decades has attracted the broad interest of institutional and retail investors towards non-directional and absolute return investment strategies. The scope of this paper mainly concerns the investigation of whether a pairs trading strategy based on the cointegration approach generates excess returns on the Swedish equity market or fails to meet initial expectations. This is enhanced by an assessment of the volatility exposure relative to an investment in the corresponding benchmark. In this research, a comprehensive analysis of the pairs trading strategy is performed by (1) implementing a long-term rolling window backtest applied on the OMX, (2) a corresponding scenario analysis of the Swedish stock market including three dierent market environments, (3) an investigation of dierent in-sample pairs selection criteria and their respective impact, (4) an extended analysis of the strategy on the EUROSTOXX50 and DAX30 to support the robustness of the obtained outcomes. The empirical results suggest that the pairs trading technique is in fact protable and superior in terms of return and risk relative to its benchmarks.