| Abstract: |
| The talk is to focus on pairs trading selling rules. In pairs trading, a long position is held in one stock and a short position is held in another. The goal is to determine the optimal time to sell the long position and repurchase the short position in order to close the pair position. This talk presents an optimal pairs-trading selling rule with trading constraints. In particular, the underlying stock prices evolve according to a two-dimensional geometric Brownian motion, and the trading permission process is given in terms of a two-state {trading allowed, trading not allowed} Markov chain. It is shown that the optimal policy can be determined by a threshold curve which is obtained by solving the associated Hamilton- Jacobi-Bellman (HJB) equations (quasi-variational inequalities). A closed-form solution is obtained. A verification theorem is provided. Numerical experiments are also reported to demonstrate the optimal policies and value functions. |
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