In "Statistical Arbitrage Trading" what if I take just the correlated securities rather than finding a cointegrated pair?
Hi Jay,
Correlated securities will not give you the desired results because such securities will not necessarily be mean reverting in nature. Statistical Arbitrage and Pairs Trading work on the premise that the pair of securities will revert back to the mean when the spread between them increases beyond a particular level. For this reason, it is necessary for the pair of securities to be co-integrated (mean reverting). In a Statistical Arbitrage model, it is a good idea to first run the correlation check to filter down the universal set of securities to a more manageable set. Post which checking for co-integration is a must in order to identify pairs of mean reverting securities.
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