Algorithmic Trading in CDS and Equity Indices Using Statistical Arbitrage

Sammanfattning: Historical data shows a strong relationship between hourly changes in CDS index iTraxx Main and equity futures EURO STOXX 50. We hypothesize that the relatively stable relationship should allow us to trade the two markets. A Markov regime switching model is introduced, distinguishing cointegrated regimes that allows the cointegration relation ship to be switched on and off. A pairs trade between the two securities is carried out in the cointegrated regimes. We show that trading exclusively in these regimes produces a significantly better performance compared to static pairs trading over the whole data set.