Preference Graphs for Multi-Pair Statistical Arbitrage Portfolios

Summary

The paper addresses a portfolio-construction problem in statistical arbitrage: signals from many pairs can conflict, making it difficult to combine opportunities across a large group of securities. It proposes representing preference relations among securities as a graph, then using that structure to reconcile contradictory pair-trading signals and construct a joint portfolio.

The reported experiments use roughly three decades of historical returns for about 500 S&P 500 stocks. The authors report robust returns under high transaction costs and improved performance as the number of securities considered increases. These results suggest that aggregating pairwise information through preference relations may help scale statistical arbitrage beyond isolated pairs. The excerpt does not specify the evaluation protocol, risk controls, or out-of-sample design, so the findings alone do not establish that the approach will perform similarly in other markets or periods.

Key ideas

• Pairwise strategies can generate contradictory signals when many security pairs are used together.
• Preference-relation graphs are proposed to reconcile those signals in portfolio construction.
• The approach aims to exploit arbitrage opportunities jointly across many securities.
• Experiments used long-run returns for roughly 500 S&P 500 stocks.
• The reported portfolio results remained robust under high transaction costs and improved with more securities.

Tags

# Statistical arbitrage portfolio construction based on preference relations


# Statistical arbitrage portfolio construction based on preference relations









Statistical arbitrage methods identify mispricings in securities with the goal of building portfolios which are weakly correlated with the market. In pairs trading, an arbitrage opportunity is identified by observing relative price movements between a pair of two securities. By simultaneously observing multiple pairs, one can exploit different arbitrage opportunities and increase the performance of such methods. However, the use of a large number of pairs is difficult due to the increased probability of contradictory trade signals among different pairs. In this paper, we propose a novel portfolio construction method based on preference relation graphs, which can reconcile contradictory pairs trading signals across multiple security pairs. The proposed approach enables joint exploitation of arbitrage opportunities among a large number of securities. Experimental results using three decades of historical returns of roughly 500 stocks from the S\&P 500 index show that the portfolios based on preference relations exhibit robust returns even with high transaction costs, and that their performance improves with the number of securities considered.

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