Correlation or cointegration?

Quant Trading Strategies & Ideas
1

Hello,



I almost finished the Statistical Arbitrage Trading course, but I still don't have the answer to my question



I am Market maker. ie quote (Bid/Ask) of new product launched by stock exchanges. I myself have to look for the best product to relieve myself. The goal is to give liquidity to new products. For example, I quote the MSCI Japan and I hedge on the Topix.

In my choice of hedge, should I take the product which has the greatest correlation with the MSCI Japan or which is co-integrated with the MSCI Japan?



Best

2

Hi,



This video of the course serves as a step-by-step guide on how to select pairs. Usually, we check both correlation and cointegration. But if you want to choose either a correlated or cointegrated pair then you should consider the following points:


  1. If you want to minimize the risk in your portfolio, you should choose a product that is co-integrated with MSCI Japan. This is because a co-integrated product will tend to move in the same direction as MSCI Japan over the long term, reducing the risk of your portfolio.


  2. If you are looking to maximize the profits of your portfolio, you may want to choose a product that is highly correlated with MSCI Japan. This is because a highly correlated product will tend to move in the same direction as MSCI Japan in the short term, providing opportunities for profit.


  3. Ultimately, the choice between a co-integrated product and a highly correlated product depends on your specific goals and risk tolerance. You should carefully consider the characteristics of each product and choose the one that best meets your needs as a market maker.



    Thanks,

    Rushda
3

Thank you Rushda