I'm very new to pairs trading, and am trying it out on a few dozen pairs.
It seems very natural to me to use a dynamic hedge ratio, as it seems likely that the ratio will move over time.
To accomplish this, I am using rolling linear regression (so I choose a lookback period of, say, 100 hours and I keep shifting this 100-hour window forward, run linear regression on that window to determine the "current" hedge ratio).
I have noticed, though, that by doing this, it seems like I can make a "stationary" spread out of just about any pair. I realize this is likely because part of the "stationarity" is due to the self-correcting nature of a rolling window regression, which over time will make the spread return to 0 by changing the hedge ratio, not because the spread actually reverted to the mean.
How can I address this? How can I tell if my spread is stationary due to real mean reversion, or just the shifting hedge ratio? Is there a better way of finding a hedge ratio?
I realize there's a lot loaded in this question, and I'll be happy to give a bounty to anyone who takes the time to respond deeply. Thank you!
Related question and discussion here: Pairs Trading - isn't any spread stationary if your rolling lin-reg window is small enough?