A New Formulation of Pair's Portfolio Selection with First Passage Time

Abstract

Abstract. Pair trading is an investment strategy to earn a pro t by taking a position on two assets whose spread (i.e., prices' difference) is expected to converge to a certain level. In this paper, we propose a simple but new formulation for portfolio selection of assets' pairs on the basis of the rst passage time (FPT) of the processes of spreads. We observed that the computed efficient frontier in terms of FPT almost corresponds to the return-based efficient frontier. Besides, obtained portfolios had practically favorable features compared to the conventional single-pair trading strategy.