Pairs Trading in the Aluminum Market: A Cointegration Approach

Abstract

This paper applies various ways of constructing statistical arbitrage trading rules for aluminum securities. The paper use daily observations of stocks, futures and two securities supposed to mirror the return of physical aluminum. We employ several sophisticated analysis of thestatistical properties of these securities and how they relate to each other. This paper appliesEngle-Granger and Johansen tests for cointegration to identify suitable securities for pairstrading. The paper is useful for speculators and hedge fund managers who want to increase theirrisk adjusted returns, as our analysis shows that trading sector neutral positions instead ofholding passive long positions in aluminum securities have significantly higher risk adjustedreturns. Our methodology is not unique for aluminum and can be transferred to other areas suchas oil or precious metals.