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I've recently been looking into pairs trading through cointegration. So far I've used the log returns of stock A and stock B in a rolling OLS to find the hedge ratio. However, I've noticed that for a pair whereby stock A and B have massive differences in price that the hedge ratio still remains small. Say for example stock A was trading at 600 a share and stock B at 1. The log returns of these two stocks won't be too far off and so the resulting hedge ratio will end up around ~0-1. Therefore I would be shorting a really small position in stock B.

I'm almost certain that I've got something wrong in the above example so feel free to correct me.

Thanks

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  • $\begingroup$ What do you mean by ~0-1? $\endgroup$ May 5, 2021 at 8:48
  • $\begingroup$ @RichardHardy That the hedge ratio will likely be in that range. $\endgroup$ May 5, 2021 at 9:49

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