Is it possible to use efficient frontier for the markowitz portfolio on pairs trading?
Im thinking at the start yes, but if i have open trades and I want to open another trade how would I calculate the weight?
Hi Jane,
Yes, it is possible to use the efficient frontier approach for a Markowitz portfolio on pairs trading. The efficient frontier represents the set of optimal portfolios that offer the highest expected returns for a given level of risk or the lowest level of risk for a given level of expected returns.
To apply the efficient frontier approach to pairs trading, you would first need to identify the pairs of securities that you want to trade. You would then estimate the expected returns, standard deviation, and correlation between the two securities in each pair. Using this information, you can calculate the weights for each security in the portfolio that will maximize the expected returns for a given level of risk or minimize the risk for a given level of expected returns.
When you have open trades and want to open another trade, you would need to adjust the weights of the existing positions in the portfolio to make room for the new trade. You can do this by using the same efficient frontier approach to calculate the new weights for all the securities in the portfolio, taking into account the existing positions and the new trade. This will ensure that the portfolio remains diversified and optimized for maximum returns with minimum risk.
I hope this helps!