FFA Working Papers 5:004 (2023)995

Copula-Based Trading of Cointegrated Cryptocurrency Pairs

Masood Tadi, Jiøí Witzany
Faculty of Finance and Accounting, Prague University of Economics and Business

This research introduces a novel pairs trading strategy based on copulas for cointegrated pairs of cryptocurrencies. To identify the most suitable pairs, the study employs linear and non-linear cointegration tests along with a correlation coefficient measure and fits different copula families to generate trading signals formulated from a reference asset for analyzing the mispricing index. The strategy's performance is then evaluated by conducting back-testing for various triggers of opening positions, assessing its returns and risks. The findings indicate that the proposed method outperforms buy-and-hold trading strategies in terms of both profitability and risk-adjusted returns.

Keywords: Capital ratio; Basel capital requirements; COVID-19 pandemic; global financial crisis
JEL classification: C33, G21, G28

Received: May 3, 2023; Revised: May 3, 2023; Accepted: May 17, 2023; Published online: January 1, 2023  Show citation

ACS AIP APA ASA Harvard Chicago Chicago Notes IEEE ISO690 MLA NLM Turabian Vancouver
Tadi, M., & Witzany, J. (2023). Copula-Based Trading of Cointegrated Cryptocurrency Pairs. FFA Working Papers, 5, Article 2023.005. https://doi.org/10.XXXX/xxx.2023.004
Download citation
  • BibTeX (.bib)
  • Bookends (.ris)
  • EasyBib (.ris)
  • EndNote (.enw)
  • EndNote 8 (.xml)
  • ISI WoS (.isi)
  • Medlars (.medlars)
  • Mendeley (.ris)
  • MODS (.xml)
  • Papers (.ris)
  • RefWorks (.txt)
  • RefManager (.ris)
  • RIS (.ris)
  • MS Word (.xml)
  • Zotero (.ris)
    • Open full article

    References

    1. Binance Crypto Derivatives (accessed 2022-11-03). https://www. binance .com/ en/support/faq/crypto-derivatives?c=4&navId=4.
    2. Broek, L van den and Zara Sharif (2018). "Cointegration-based pairs trading framework with application to the Cryptocurrency market". Bachelor Thesis, Erasmus University Rotterdam.
    3. Casella, George and Roger L Berger (2021). Statistical inference. Cengage Learning. Chen, Huafeng et al. (2019). "Empirical investigation of an equity pairs trading strategy". In: Management Science 65.1, pp. 370-389. Go to original source...
    4. Cherubini, Umberto et al. (2011). Dynamic copula methods in finance. John Wiley & Sons. Go to original source...
    5. Czado, Claudia (2019). "Analyzing dependent data with vine copulas". In: Lecture Notes in Statistics, Springer. Go to original source...
    6. Enders, Walter and Pierre L Siklos (2001). "Cointegration and threshold adjustment". In: Journal of Business & Economic Statistics 19.2, pp. 166-176. Go to original source...
    7. Engle, Robert F and Clive WJ Granger (1987). "Co-integration and error correction: representation, estimation, and testing". In: Econometrica: journal of the Econometric Society, pp. 251-276. Go to original source...
    8. Ferreira, Luan (2008). "New tools for spread trading". In: Futures 37.12, pp. 38-41. Gatev, Evan, William N Goetzmann, and K Geert Rouwenhorst (2006). "Pairs trading: Performance of a relative-value arbitrage rule". In: The Review of Financial Studies 19.3, pp. 797-827. Go to original source...
    9. Gudendorf, Gordon and Johan Segers (2010). "Extreme-value copulas". In: Copula theory and its applications. Springer, pp. 127-145. Hansen, Bruce E and Byeongseon Seo (2002). "Testing for two-regime threshold cointegration in vector error-correction models". In: Journal of econometrics 110.2, pp. 293-318. Go to original source...
    10. Harris, Lawrence (1997). "Decimalization: A review of the arguments and evidence". In: Unpublished working paper, University of Southern California.
    11. Huck, Nicolas (2015). "Pairs trading: does volatility timing matter?" In: Applied Economics 47.57, pp. 6239-6256. Go to original source...
    12. Johansen, Soren (1991). "Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models". In: Econometrica: journal of the Econometric Society, pp. 1551-1580. Go to original source...
    13. Kakushadze, Zura and Willie Yu (2019). "Altcoin-Bitcoin Arbitrage". In: Bulletin of Applied Economics 6.1, pp. 87-110. Go to original source...
    14. Kapetanios, George (2005). "Unit-root testing against the alternative hypothesis of up to m structural breaks". In: Journal of Time Series Analysis 26.1, pp. 123-133. Go to original source...
    15. Kapetanios, George, Yongcheol Shin, and Andy Snell (2003). "Testing for a unit root in the nonlinear STAR framework". In: Journal of Econometrics 112.2, pp. 359-379. Go to original source...
    16. - (2006). "Testing for cointegration in nonlinear smooth transition error correction models". In: Econometric Theory, pp. 279-303.
    17. Keshavarz Haddad, GholamReza and Hassan Talebi (2023). "The profitability of pair trading strategy in stock markets: Evidence from Toronto stock exchange". In: International Journal of Finance & Economics 28.1, pp. 193-207. Go to original source...
    18. Klement, Erich Peter, Radko Mesiar, and Endre Pap (2002). "Invariant copulas". In: Kybernetika 38.3, pp. 275-286.
    19. Krauss, Christopher (2017). "Statistical arbitrage pairs trading strategies: Review and outlook". In: Journal of Economic Surveys 31.2, pp. 513-545. Go to original source...
    20. Krauss, Christopher and Johannes St¨ubinger (2017). "Non-linear dependence modelling with bivariate copulas: Statistical arbitrage pairs trading on the S&P 100". In: Applied Economics 49.52, pp. 5352-5369. Go to original source...
    21. Leung, Tim and Hung Nguyen (2019). "Constructing cointegrated cryptocurrency portfolios for statistical arbitrage". In: Studies in Economics and Finance 36.3, pp. 581-599. Go to original source...
    22. Liew, Rong Qi and Yuan Wu (2013). "Pairs trading: A copula approach". In: Journal of Derivatives & Hedge Funds 19.1, pp. 12-30. Go to original source...
    23. Nelsen, Roger B (2007). An introduction to copulas. Springer Science & Business Media.
    24. Phillips, Peter CB and Sam Ouliaris (1990). "Asymptotic properties of residual based tests for cointegration". In: Econometrica: journal of the Econometric Society, pp. 165-193. Go to original source...
    25. Pritchard, Brendan Padraic Anson (2018). "Digital asset arbitrage". PhD thesis. Fundacao Getulio Vargas's Sao Paulo School of Business Administration.
    26. Rad, Hossein, Rand Kwong Yew Low, and Robert Faff (2016). "The profitability of pairs trading strategies: distance, cointegration and copula methods". In: Quantitative Finance 16.10, pp. 1541-1558. Go to original source...
    27. Silva, Fernando AB Sabino da, Flavio A Ziegelmann, and Joao F Caldeira (2023). "A pairs trading strategy based on mixed copulas". In: The Quarterly Review of Economics and Finance 87, pp. 16-34. Go to original source...
    28. Stander, Yolanda, Daniel Marais, and Ilse Botha (2013). "Trading strategies with copulas". In: Journal of Economic and Financial Sciences 6.1, pp. 83-107. Go to original source...
    29. Tadi, Masood and Irina Kortchemski (2021). "Evaluation of dynamic cointegration-based pairs trading strategy in the cryptocurrency market". In: Studies in Economics and Finance. Go to original source...
    30. Terasvirta, Timo (1994). "Specification, estimation, and evaluation of smooth transition autoregressive models". In: Journal of the american Statistical association 89.425, pp. 208-218. Go to original source...
    31. Vidyamurthy, Ganapathy (2004). Pairs Trading: quantitative methods and analysis. Vol. 217. John Wiley & Sons.
    32. Xie,Wenjun, Rong Qi Liew, et al. (2016). "Pairs trading with copulas". In: The Journal of Trading 11.3, pp. 41-52. Go to original source...
    33. Xie, Wenjun and Yuan Wu (2013). "Copula-based pairs trading strategy". In: Asian Finance Association (AsFA). Go to original source...
    34. Zivot, Eric and Donald W K Andrews (2002). "Further evidence on the great crash, the oil-price shock, and the unit-root hypothesis". In: Journal of business & economic statistics 20.1, pp. 25-44. Go to original source...

    Return to the content