# Tag Info

Accepted

### Does Chan use the wrong state transition model in his Kalman filter code?

In addition to getting the right transition model for the Kalman filter, the main obstacle to optimizing filter performance is to implement an optimal initialization. I use an iterative approach to ...
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Accepted

### What is the reason for using log prices in Pairs Trading (Cointegration)?

I'm assuming that the paper you're referring to uses the Engle-Granger test for cointegration. The standard test procedure checks for unit roots in the residuals of a linear regression. It is a "...
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### Looking for materials regarding Pair Trading

Here is a literature list from my masters thesis on stat arb. Lederman, J., (1996). Market Neutral: Long/Short Strategies for Every Market Environment, 2. – 3. lpp. Gatev, E., Goetzman, W. N....
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### Imposing Restrictions on Cointegrating Vectors, R example

I know this was asked almost two years ago, but I thought I'd answer the question. It appears that the H that you want to estimate is identical to the values you received from the Johansen test, ...

### What is the reason for using log prices in Pairs Trading (Cointegration)?

This is for better linearity/normality in the QQ plot at the tails, which as both @noob2 and @rkr allude to, give a better fit and hence better properties for normalizing the residuals with z-scoring ...
• 304

### Are there any papers about cointegration consisting of time series of more than two assets?

Technically, if you do PCA on the yield curve (live dangerously!, do it in levels), the first two PCAs are nonstationary. The third is questionable. Note that this is a perfectly valid way of looking ...
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1 vote

### Cointegration and Ratio Pair Trading

No. In the above equation, you mentioned the spread as the ratio of prices and not of log prices. Also, you verified the spread's cointegration using $A - \gamma \cdot B$ and not $A/B$ as the input ...
• 31
1 vote

### Cointegration and Ratio Pair Trading

If I want to trade the spread, should I model the OLS as $ln(A)=−γ⋅ln(B)+ \epsilon$? It depends on how you define your spread. If you used log return as spread then use log return in OLS also. If you ...
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1 vote

### If two price series are cointegrated but not correlated, how do I find the hedge ratio?

To find the hedge ratio you can run the Johansen Cointegration test and the eigen-vector corresponding to the largest eigenvalue would give you the hedge ratio, you can see with a bit mathematical ...
1 vote

### If two price series are cointegrated but not correlated, how do I find the hedge ratio?

If two price series are cointegrated, you can run the linear regression to calculate the hedge ratio. The linear regression is in the form: $$y = \beta X + \epsilon$$ where, $y$ is the dependent ...
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1 vote

### When constructing a cointegrating series, does choosing the linear regression with the lowest ADF test statistic yield the optimal hedging ratio?

You are right that it is a "very arbitrary procedure". More charitably it is a "hack" that gives a practical solution without addressing the fundamental issue. The very fact that when you do an OLS ...
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1 vote

### Cointegration vs combination of returns

The reason we look for cointegration is to find some long-term relationship between levels of prices. When you use the returns, you are seeking a relationship between first differences, which are ...
1 vote

### What does the cointegration coefficient represent in pairs trading when cointegrating log stock prices?

It should mean market values (instead of shares). You can see this more obviously by creating an "artificial stock" (stock C) which price equals the price of stock B divided by 10,000 (same ...
1 vote

### Simulate non-stationary time series with cointegration

Simulate Random Walk Series We can now simulate a random walk series in R as shown below: RW <- arima.sim(model= list(order = c(0, 1, 0)), n=200) We can plot the newly generated series as well ...
1 vote

### What's the practical difference between the Johansen vs Engle-Granger tests for cointegration?

Neither. This question and its references suggest that the Philipis Ouliaris (1990) test is a significant improvement over EG ADF and JCT. Given the automation, you should probably run all three ...
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### cointegration applied to Portfolio Construction & Risk management

Cointegration really shouldn't be a risk relationship. It's a sort of equilibrium pricing relationship. If you take a bunch of prices/yields and regress them in levels, you are looking for a 'fair ...
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1 vote

### How do you decide what time frame you're going to use when testing for cointegration?

If the data generating process was fixed over time, you would choose the longest available data sample for cointegration testing -- because a larger sample yields higher power for the test. If the ...
• 3,156

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