Statistical Arbitrage Algorithmic Trading Insights and Techniques ANDREW POLE John Wiley & Sons, Inc. 7700++ DDVVDD’’ss FFOORR SSAALLEE && EEXXCCHHAANNGGEE wwwwww..ttrraaddeerrss--ssooffttwwaarree..ccoomm wwwwww..ffoorreexx--wwaarreezz..ccoomm wwwwww..ttrraaddiinngg--ssooffttwwaarree--ccoolllleeccttiioonn..ccoomm wwwwww..ttrraaddeessttaattiioonn--ddoowwnnllooaadd--ffrreeee..ccoomm CCoonnttaaccttss aannddrreeyybbbbrrvv@@ggmmaaiill..ccoomm aannddrreeyybbbbrrvv@@yyaannddeexx..rruu SSkkyyppee:: aannddrreeyybbbbrrvv Statistical Arbitrage Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia. Wiley is globally committed to developing and marketing print and electronic products and servicesforourcustomers’professionalandpersonalknowledgeand understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated indi- vidual investorsand theirfinancialadvisors. Booktopicsrange from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more. For a list of available titles, visit our Web site at www.Wiley Finance.com. Statistical Arbitrage Algorithmic Trading Insights and Techniques ANDREW POLE John Wiley & Sons, Inc. Copyright(cid:1)c 2007byAndrewPole.Allrightsreserved. PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey. PublishedsimultaneouslyinCanada. WileyBicentenniallogo:RichardJ.Pacifico. Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmittedin anyformorbyanymeans,electronic,mechanical,photocopying,recording,scanning,or otherwise,exceptaspermittedunderSection107or108ofthe1976UnitedStatesCopyright Act,withouteitherthepriorwrittenpermissionofthePublisher,orauthorizationthrough paymentoftheappropriateper-copyfeetotheCopyrightClearanceCenter,Inc.,222 RosewoodDrive,Danvers,MA01923,(978)750-8400,fax(978)750-4470,orontheWeb atwww.copyright.com.RequeststothePublisherforpermissionshouldbeaddressedtothe PermissionsDepartment,JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030, (201)748-6011,fax(201)748-6008,oronlineathttp://www.wiley.com/go/permission. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheir besteffortsinpreparingthisbook,theymakenorepresentationsorwarrantieswithrespectto theaccuracyorcompletenessofthecontentsofthisbookandspecificallydisclaimanyimplied warrantiesofmerchantabilityorfitnessforaparticularpurpose.Nowarrantymaybecreated orextendedbysalesrepresentativesorwrittensalesmaterials.Theadviceandstrategies containedhereinmaynotbesuitableforyoursituation.Youshouldconsultwitha professionalwhereappropriate.Neitherthepublishernorauthorshallbeliableforanylossof profitoranyothercommercialdamages,includingbutnotlimitedtospecial,incidental, consequential,orotherdamages. Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,please contactourCustomerCareDepartmentwithintheUnitedStatesat(800)762-2974,outside theUnitedStatesat(317)572-3993orfax(317)572-4002. Wileyalsopublishesitsbooksinavarietyofelectronicformats.Somecontentthatappearsin printmaynotbeavailableinelectronicbooks.FormoreinformationaboutWileyproducts, visitourWebsiteatwww.wiley.com. LibraryofCongressCataloging-in-PublicationData: Pole,Andrew,1961– Statisticalarbitrage:algorithmictradinginsightsandtechniques/ AndrewPole. p.cm.—(Wileyfinanceseries) Includesbibliographicalreferencesandindex. ISBN978-0-470-13844-1(cloth) 1.Pairstrading.2.Arbitrage---Mathematicalmodels.3.Speculation- -Mathematicalmodels. I.Title. HG4661.P65 2007 332.64’5 — dc22 2007026257 ISBN978-0-470-13844-1 PrintedintheUnitedStatesofAmerica 10 9 8 7 6 5 4 3 2 1 To Eliza and Marina