PAIRS TRADING UNDER A MEAN REVERSION MODEL WITH REGIME SWITCHING

This paper is about an optimal pairs trading rule. A pairs position consists of a long position in one stock and a short position in the other. The problem is to find stopping times to open and then close the pairs position to maximize expected reward functions. In this paper, we consider the optimal pairs trading rule under a mean reversion model with regime switching. The optimal policy is characterized by threshold levels obtained by solving the associated HJB equations (quasi-variational inequalities). Moreover, numerical examples are provided to illustrate the results.