Copula Mispricing Indices for Dollar-Neutral Pairs Trading
Summary
This implementation describes a pairs strategy that estimates conditional probabilities from a fitted copula applied to each asset’s return ranks. It converts prices to returns, maps returns through marginal cumulative distribution functions, and uses the copula to calculate two mispricing indices. Each index is accumulated into a flag, and configurable thresholds open or close long-short positions. The code supports alternative open and exit logic, stop-loss boundaries, and dollar-neutral unit sizing.
The document explains the mechanics and cites the 2014 Xie et al. paper as its basis, but provides no performance results or validation. It highlights an implementation choice: flags reset when an exit occurs, with reset priority taking precedence over opening a new position. The excerpt is incomplete, so some position and flag logic is unavailable. The method also depends on fitted copula and marginal distributions; the notes do not discuss estimation quality, transaction costs, or robustness across pairs and market regimes.
Key ideas
- The strategy transforms asset returns into marginal quantiles before estimating conditional probabilities with a fitted copula.
- Two conditional mispricing indices are accumulated into history-dependent flags that drive pair positions.
- Opening, exit, and stop-loss thresholds are configurable, with the documented default logic resetting flags after an exit.
- Dollar-neutral positions are converted into security units using current prices and a chosen capital multiplier.
- The excerpt gives implementation mechanics but no empirical evidence of profitability or robustness.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.