Pair Trading

CONTENTS
ACKNOWLEDGEMENT …………………………..............................................1
EXECUTIVE SUMMARY ………………………………………………………………..2
PAIRS TRADING: INTRODUCTION……………………………………………………..3
KEY CHARACTERISTICS………………………………………………………………….5
INSTRUMENTS USED FOR PAIRS TRADING ………………………………………...8
STRATEGY …………………………………………………………………………………10
TESTING FOR MEAN REVERSION ……………………………………………………10
PAIRS TRADING MODEL ………………………………………………………………..11
a. Screening for Pairs
b. Trading Rules
c. Risk Management
d. Risk involved
STEPS IN PAIR TRADING ……………………………………………………………….14
CASES ……………………………………………………………………………………….15
a. Bank of Baroda –Bank of India Pair
b. Infosys—TCS Pair
c. APIL—CESC Pair
CONCLUSION …………………………………………………………………………..22
BIBLIOGRAPHY …………………………………………………………………………23 ACKNOWLEDGEMENT

I take immense pleasure in submitting the project on “PAIR TRADING AND CONVERGENGE ARBITRAGE” This project has helped me understand the intricacies involved in pair trading.

Firstly I would like to thank Prof.Navin Bhatia for giving me an
Opportunity to work with him. I would like to acknowledge with special thanks the help of Dr. Poornima Dubey for helping in compiling and completion of the project and express my earnest gratitude towards her and for the inputs provided by her which helped me in successfully completing the project.

I also thank Prof. P.L Arya for giving me an opportunity to undertake this project. Finally I must express my heartiest gratitude toward all those who helped me directly or indirectly in the completion of this project.

EXECUTIVE SUMMARY

For the purpose of my summer internship which is a part of our curriculum in MMS, I got an opportunity to be a part of a prestigious project with Prof Naveen Bhatia. The project helped me in understanding the mechanics of convergence arbitrage and exposed me to the market parameters that can be taken as useful measures for