Quotation Altay, Sühan, Colaneri, Katia, Eksi-Altay, Zehra. 2020. Optimal Convergence Trading with Unobservable Pricing Errors. Annals of Operations Research.


RIS


BibTeX

Abstract

We study a dynamic portfolio optimization problem related to convergence trading, which is an investment strategy that exploits temporary mispricing by simultaneously buying relatively underpriced assets and selling short relatively overpriced ones with the expectation that their prices converge in the future. We build on the model of Liu and Timmermann (Rev Financ Stud 26(4):1048–1086, 2013) and extend it by incorporating unobservable Markov-modulated pricing errors into the price dynamics of two co-integrated assets. We characterize the optimal portfolio strategies in full and partial information settings under the assumption of unrestricted and beta-neutral strategies. By using the innovations approach, we provide the filtering equation which is essential for solving the optimization problem under partial information. Finally, in order to illustrate the model capabilities, we provide an example with a two-state Markov chain.

Tags

Press 'enter' for creating the tag

Publication's profile

Status of publication Published
Affiliation WU
Type of publication Journal article
Journal Annals of Operations Research
Citation Index SCI
WU Journalrating 2009 A
WU-Journal-Rating new FIN-A, INF-A, STRAT-B, WH-B
Language English
Title Optimal Convergence Trading with Unobservable Pricing Errors
Year 2020
Reviewed? Y
URL https://link.springer.com/article/10.1007/s10479-020-03647-z
DOI http://dx.doi.org/10.1007/s10479-020-03647-z
Open Access N

Associations

People
Altay, Sühan (Details)
Eksi-Altay, Zehra (Details)
External
Colaneri, Katia (Department of Economics and Finance, University of Rome Tor Vergata, Italy)
Organization
Institute for Statistics and Mathematics IN (Details)
Research areas (ÖSTAT Classification 'Statistik Austria')
1118 Probability theory (Details)
1137 Financial mathematics (Details)
Google Scholar: Search