Statistical arbitrage commonly referred to as pairs trading entails the identification and acquisition or short selling of two cointegrated securities according to a discrepancy or delineation in price. Thus, if two indices such as BZ and WTI that typically present positive correlation and cointegration display a transient discrepancy in their correlation where one lags the other, the latter may be acquired and the former shorted, so that assuming the indices correlation reverts or potentially inverts to some extent, the product of the discrepancy and invested capital becomes profit. The underlying assumption of statistical arbitrage or pairs trading is that a correlation discrepancy among the pair is temporary and subject to eventual normalization or reversion.
Introduction to Fundamental Analysis and Intrinsic Valuation Methods, Algorithmic Trading, Derivatives, and Arbitrage
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