On Pairs Trading : A Comparison between Cointegration and Correlation as Selection-criteria

Abstract: In this paper we show that pairs of stocks which have a true long run equilibrium (cointegration) yield a higher return than pairs of stocks that relies on a more spurious relationship (correlation) when applying Pairs Trading for a trading period from 31/12-09 to 25/6-14. We get an annual return for the cointegration portfolio of 4,15%, with a Sharpe-ratio of 0,87. For the correlated portfolio we get 2,08% and 0,45, respectively. The Sharpe-ratio for a buy-and-hold market index during the same period was 1,08.