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Testing Cointegration Pairs Trading in PepsiCo and Coca-Cola

Article arXiv papers · Author: Davide Graziano
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Summary

This case study tests whether a cointegration-based pairs strategy for PepsiCo and Coca-Cola is statistically sound and economically viable. It estimates the spread's mean-reversion behavior using earlier data, holds those statistical estimates fixed, and optimizes threshold-based trading rules on a later in-sample period. The excerpt does not specify the entry and exit thresholds or report detailed performance statistics.

The evaluation includes transaction-cost and parameter sensitivity checks, walk-forward validation, and Adjusted and Deflated Sharpe Ratios. It also examines out-of-sample performance and compares fixed hedge ratios with rolling ordinary least squares and a Kalman filter. The reported conclusion is that weakening mean reversion in the spread undermines the strategy outside the training period. This highlights a key limitation of historical cointegration: a relationship that supports in-sample optimization may not persist. The excerpt provides no numerical results or cost assumptions, so it is not possible to quantify the strategy's returns or assess its relative performance from this description alone.

Key ideas

  • The study tests a cointegration-based pairs strategy using PepsiCo and Coca-Cola.
  • It estimates spread behavior on earlier data and optimizes trading thresholds in-sample.
  • Robustness checks include costs, parameter sensitivity, walk-forward validation, and adjusted Sharpe measures.
  • Rolling OLS and a Kalman filter are used to examine changing hedge ratios.
  • The reported out-of-sample weakness is linked to declining mean-reversion dynamics.

Tags

EquitiesPairs tradingMean reversionBacktestingRisk management

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Full text
# From Cointegration to Out-of-Sample Failure: A Pairs-Trading Case Study on PEP-KO


# From Cointegration to Out-of-Sample Failure: A Pairs-Trading Case Study on PEP-KO









This paper examines whether a cointegration-based pairs trading strategy between PepsiCo and The Coca-Cola Company is statistically robust and economically exploitable. We first test for cointegration and estimate the spread's mean-reversion dynamics over 2013-2018, then hold these statistical parameters fixed and optimise a threshold-based trading strategy in-sample over 2018-2023. Robustness is assessed through transaction-cost and parameter sensitivity tests, walk-forward validation, and Adjusted and Deflated Sharpe Ratios. The strategy is then evaluated out-of-sample from 2023 to the present, including an analysis of time-varying hedge ratios using rolling OLS and a Kalman filter. The results show that weakening mean-reversion dynamics in the spread undermine the effectiveness of the strategy out-of-sample.

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