Arbitrage profit from pairwise correlation: evidence from Thailand

Abstract

This paper aims to examine the usefulness of the Dynamic Conditional Correlation in the aspect of pair trade. Since one of the challenges in the pair trading is pair formation, this research would like to fulfill and find a new method for pair formation. Also, not only find the effective way to form pair we also examine whether this strategy can generate an abnormal return by constructs the portfolio where short one stock and long another one, by this investor can enjoy a 2-way price spread. The finding in this suggests that first by using Dynamic Conditional Correlation to form pair can generate higher of winning pair than losing pair. The secondary, abnormal return does exist in Stock Exchange of Thailand in a specific period. Also, using price information from extraordinary events can generate an annualized abnormal return around 39% higher than the normal period.