Pairs trading with commodity futures: evidence from the Chinese market
Abstract
Purpose
The purpose of this paper is to compare the profitability of different pairs selection and spread trading methods using the complete data set of commodity futures from Dalian Commodity Exchange, Shanghai Futures Exchange and Zhengzhou Commodity Exchange.
Design/methodology/approach
Paris trading methods that are proposed in the literature are compared in terms of the risk-adjusted returns visa in-sample and out-of-sample backtesting and bootstrapping for robustness.
Findings
The empirical results show that pairs trading in the Chinese commodity futures market offers high returns, whereas, the profitability of these strategies primarily depends on the identification of suitable pairs. The observed high returns are a compensation for the spread divergence risk during the potentially longer holding periods, which implies that the maximum drawdown is more crucial compared to other risk-adjusted return measures such as the Sharpe ratio.
Originality/value
Complementary to the existing literature, for the Chinese commodity futures market, it is shown that if shorter maximum holding periods are introduced for the spread positions, then the pairs trading profits decreases. Therefore, the returns do not necessarily imply market inefficiency when the higher maximum drawdown associated with the holding period of the spread position is taken into account.
Keywords
Acknowledgements
The authors would like to acknowledge the gracious support provided by the EPSRC and ESRC Centre for Doctoral Training on Quantification and Management of Risk & Uncertainty in Complex Systems & Environments (EP/L015927/1) and the Research Institute of Quantitative Finance at Xi’an Jiaotong-Liverpool University. The authors would like to thank participants at the 1st Annual China Derivatives Markets Conference (CDMC), the 2nd Workshop on Quantitative Finance organized by the Research Institute of Quantitative Finance, and the seminar talks at the University of Liverpool and Xi’an Jiaotong-Liverpool University, as well as Dr Hongsong Chou for helpful comments. Any errors, if found, in the paper are ours.
Citation
Yang, Y., Goncu, A. and Pantelous, A. (2017), "Pairs trading with commodity futures: evidence from the Chinese market", China Finance Review International, Vol. 7 No. 3, pp. 274-294. https://doi.org/10.1108/CFRI-09-2016-0109
Publisher
:Emerald Publishing Limited
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