Pairs Trading with International Country ETFs

Summary

The document describes a pairs trading strategy using 22 international country ETFs. It normalizes dividend-inclusive total return series, selects the five pairs with the smallest cumulative price distance over a 120-day formation period, then trades them for a 20-day period. A position opens when the spread moves beyond half its historical standard deviation: the trader buys the relatively cheap ETF and shorts the relatively expensive one. Positions close when the pair converges or the trading period ends, and pairs receive equal weights with daily portfolio rebalancing.

The proposed rationale is that ETFs diversify company-specific shocks and that formerly cointegrated markets may share economic return drivers. The cited study reports that international ETF pairs trading generated returns partly explainable by economic factors. The page also cautions that this particular strategy has a small positive equity-market correlation, limiting its value as a bear-market hedge. Results are described without detailed transaction-cost, implementation, or robustness evidence for this specific setup.

Key ideas

• The strategy forms candidate pairs from 22 international ETFs using a 120-day formation window.
• It selects five pairs with the smallest distance between normalized total return series.
• A trade begins when pair divergence exceeds half its historical standard deviation.
• The strategy buys the relatively undervalued ETF and shorts the relatively overvalued ETF.
• Positions close at convergence or after the 20-day trading window, with equal weighting and daily rebalancing.
• The cited research reports returns but the page says the strategy retains a small positive correlation with equities.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.