Copula-Based Pairs Trading Strategy

Pairs trading is a technique that is widely used in the financial industry and its profitability has been constantly documented for various markets under different time periods. The two most commonly used methods in pairs trading are distance method and co-integration method. In this paper, we propose an alternative approach for pairs trading using copula technique. The proposed method can capture the dependency structure of co-movement between the stocks and is more robust and accurate. Distance method and co-integration method can be generalized as special cases of the proposed copula method under certain dependency structure