Investigating the features of pairs trading strategy: A network perspective on the Chinese stock market

Abstract We systematically investigate the features of pairs trading strategy from a network perspective. Based on the cointegration theory, we construct the full graphs (FGs) and minimum spanning trees (MSTs) in terms of the cointegration matrix by using daily stock prices from the Chinese stock market around the launch of the margin-trading and short-selling (MTSS) programme. The static and dynamic features of the networks are analyzed with respect to the formation and evolution of edges. Our results show (i) that the assets allowed MTSS or within the same industry are more inclined to form trading pairs, (ii) that the cointegration relationships among trading pairs are as fragile as only a few number of them survived from one period to the next, (iii) that the movement of cointegration relationships is independent to stock market trends, confirming that pairs trading is a market neutral strategy, and (iv) that over 45% trading pairs are excluded in the re-occurrence circles of edges within 12 months, indicating that a considerable number of trading pairs are unsteady and investors should carefully pick pairs for trading in such short-term speculations.