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I noticed that in the pair trading, some measure the spread on pricing and some measure the spread on return. Both methods make sense, it is intuitve to model price, but convergence of return means long stronger return and short weaker return which also leads to profit.

Has anyone compared the benefit of pair trading on spread or return?

Thanks in advance.


One example of pair on return instead of price comes from the following work:

Chen, H. (Jason), Chen, S. (Jenny), Chen, Z., & Li, F. (2019). Empirical Investigation of an Equity Pairs Trading Strategy. Management Science, 65(1), 370–389. https://doi.org/10.1287/mnsc.2017.2825

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    $\begingroup$ Could you provide a reference (eg. research paper) where they use spread on returns for pairs trading? $\endgroup$
    – Pleb
    Commented Oct 5, 2022 at 8:50
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    $\begingroup$ @Pleb, thats a good idea. Here I have provided an example $\endgroup$
    – Yang
    Commented Oct 5, 2022 at 9:29

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