Empirical Investigation of an Equity Pairs Trading Strategy

Abstract

We show that an equity pairs trading strategy generates large and significant abnormal returns. We find that this return is not driven purely by the short-term reversal of returns. The evidence related to the cross-sectional variation, the time-series variation, and the persistence of the pairs trading profits, and the determinants of return correlations is consistent with the delay in information diffusion as the driver for the pairs trading strategy. Evidence from the liquidity factor and the recent financial crisis suggests that the short-term liquidity provision is not the main cause of the pairs trading strategy.