Dynamic ETF Pairs Trading System. Evidence From Australia

Abstract

This study evaluates the profitability of dynamic pairs trading strategies using a proposed 3-step pairs selection approach. We extend the pairs trading methodology employed by Miao (2014) to the broad-based exchange traded funds (ETFs) listed on the Australian Securities Exchange (ASX). The 3-step approach incorporates the correlation, cointegration and error correction coefficient as the pre-selection criteria during the formation period. In the subsequent trading period, we employ a daily re-calibration of the parameters using a 252-day rolling window from January 1, 2013 to September 30, 2015. We developed a real-time trading system using the Java programming language and KDB database, and back test the strategies using tick-by-tick historical quotes during the trading period. The back testing of the top five ETF pairs: ISO-SSO, IOZ-VAS, IOZ-STW, STW-VAS and STW-SFY yield cumulative returns of 10.08%, 4.41%, 19.70%, 62.27%, 46.60% and Sharpe ratios of 2.21, 1.00, 9.29, 15.12, 11.17 respectively. The maximum draw down is -32.47% over the trading period.