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vt2009
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Posts: 8
Joined: May 4th, 2010, 2:40 pm

Correlation in Pairs Trading

February 4th, 2011, 5:56 pm

I am running a simple pairs trading model based on equity correlation. I am looking to explore a more refined filter for determining whether to trade a pair than my current minimum R squared value filter. From someone with experience, what is the best avenue to begin this approach? I have read that the Johansen test for cointegration is better to use that ADF, and have considered VECM models as well. I am very familiar with Linear Regression and I understand the concept of stationarity and cointegration but have never implemented these numerical processes in excel before. I'd like some guidance going from my time series of asset prices to the output of whether they are cointegrated order I or not.
 
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tagoma
Posts: 18685
Joined: February 21st, 2010, 12:58 pm

Correlation in Pairs Trading

February 4th, 2011, 11:13 pm

(take good care not to mix up correlation and cointegration)on quantcode.com one guy uploaded a "Cointegration analysis using Johansen procedure" excel file. you have to sign up to download from quantcode. but it's free.personally, i wouldn't have used Excel, but more surely R tools. and i know that it's a matter of few click with Matlab (i wish i had a license ....).my londonian friend CointegrationMan built a cool small software you may be interested in. please, visit : http://matlaber.blogspot.com
Last edited by tagoma on February 4th, 2011, 11:00 pm, edited 1 time in total.
 
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marcoaaguiar
Posts: 10
Joined: February 4th, 2011, 4:03 pm

Correlation in Pairs Trading

February 8th, 2011, 11:47 pm

In Carol Alexander's book, Markets Model, she said that the Engle-Granger Model is easy to implement in Excel, and its Ok for pair traiding. For basket trading the other choice would be Johansen model but it's hard to implement in excel.