What is Arbitration?
Arbitrage is a trading strategy that seeks to take advantage of price differences between two or more markets. The idea is to buy an asset in a market where its price is low and sell it in another where its price is higher, obtaining a risk-free profit.
What is Cointegration?
Cointegration is a statistical concept that indicates a long-term relationship between two or more assets. If two assets are cointegrated, it means that their prices move together predictably over time, although they may deviate temporarily.
Arbitration Strategy Based on Cointegration
Identification of Cointegrated Assets:
First, we identify two or more assets whose price series are cointegrated. This can be done using statistical tests.
Relationship Modeling:
Once the cointegrated assets are identified, we model their relationship. For example, if we have two assets A and B, we can represent the price of B as a linear combination of the price of A.
Spread Calculation:
We calculate the "spread" between the assets, which is the difference between the current price of B and the price predicted by the model based on A.
Trading Strategy:
Position Opening:
If the S spread deviates significantly from its mean (e.g., more than two standard deviations), this indicates an arbitrage opportunity.
Position Closing:
When the spread returns to its average, we close the positions to make a profit.
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