Abstract
In this paper, we make use of the replicating asset for statistical arbitrage trading, where the replicating asset is constructed by a portfolio that mimics the returns from a factor model. Using the replicating asset in the context of statistical arbitrage has never been done before in the literature. A novel optimal statistical arbitrage trading model is applied, and we derive the average transaction length and return for the Berkshire A stock and its replicating asset. The results show that the statistical arbitrage method proposed by Bertram (2010) is profitable by using the replicating asset. We also compute the average returns under different transaction costs. For the statistical arbitrage using the replicating asset of the factor model, average annual returns were at least 33%. Robustness is examined with the S&P500. Our results can provide hedge fund managers with a new technique for conducting statistical arbitrage.
Highlights
Pairs trading is a statistical arbitrage concept, and it has two types: one is the statistical arbitrage, and the other is risk arbitrage
This study provides a novel method of using replicating assets formed by factor models for optimal statistical arbitrage
Our experiments illustrate the viability of forming the synthetic asset from the original target asset and the replicating asset constructed from factor models
Summary
Pairs trading is a statistical arbitrage concept, and it has two types: one is the statistical arbitrage, and the other is risk arbitrage. Our main results show that the replicating portfolio can be effectively paired with the original asset in a pairs trading statistical arbitrage framework and verify that this method is rewarded. The. Optimal statistical arbitrage trading of Berkshire Hathaway stock and its replicating portfolio main contribution of this paper is using the factor model to form a replicating asset and constructing the synthetic asset with other assets for statistical arbitrage. We form the replicating asset (portfolio) by using the Buffett- and five-factor model following the method described in Asness et al [21] We verify that this method can create replicating assets that exhibit similar properties to Berkshire A stock and that the replicating asset can be paired with the original Berkshire A stock for statistical arbitrage, profitably.
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