Cointegration-Based Statistical Arbitrage (Pairs and Triplets Trading)

This project explores statistical arbitrage via cointegration-based pairs trading, focusing on whether apparent mean-reverting relationships actually translate into tradable edge after realistic constraints.

Rather than assuming cointegration automatically implies profitability, the goal here is to stress-test the full pipeline — from statistical tests to signal construction, execution logic, and risk-adjusted performance.

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Project Objectives

• Identify cointegrated asset pairs using Engle–Granger and Johansen tests
• Estimate mean-reversion speed via half-life calculations
• Construct trading signals based on z-scored spreads
• Backtest multiple strategy variants with realistic assumptions
• Evaluate performance using Sharpe Ratio, drawdowns, and volatility targeting
• Explicitly study where intuition breaks down

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Data

• Universe: Equity pairs (5 years of daily price data) in Indian Automobile Industry.
• Frequency: Daily
• Source: Yahoo Finance (via yfinance)
• Equities:

• Maruti Suzuki India Limited
• Mahindra & Mahindra
• Tata Motors
• Bajaj Auto
• Hero MotoCorp
• TVS MotorCompany
• Eicher Motors
• Ashok Leyland

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Methodology Overview

1. Cointegration Testing

• Engle–Granger test
  • Quick pairwise screening
• Johansen test
  • Multivariate cointegration validation
  • Eigenvalue-based rank selection
  • Cointegration vectors extracted and normalized

Key takeaway:
Statistical cointegration ≠ economically useful mean reversion.

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Results (so far)

So far I have only implemented statistical analysis using static beta.

Based on Engle-Granger there are 4 co-integrated pairs:

• Ashok Leyland, Eicher Motors
• Ashok Leyland, Maruti Suzuki India Limited
• Eicher Motors, Maruti Suzuki India Limited
• Maruti Suzuki India Limited, TVS MotorCompany

At a daily frequency the half-life of these pairs indicated that it is not tradable. Half lives:

• Ashok Leyland, Eicher Motors -> 5927.07 days
• Ashok Leyland, Maruti Suzuki India Limited -> 12000.85 days
• Eicher Motors, Maruti Suzuki India Limited -> 23848.02 days
• Maruti Suzuki India Limited, TVS MotorCompany -> Neg => Spread is not mean reverting.

Based on intuition, there is 1 triplet:

• Ashok Leyland, Eicher Motors, Maruti Suzuki India Limited

Half-life obtained from Johannsen test: 22.43 days.

The cumulative PnL using this triplet looks like:

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Future Plans

Will test the same with rolling hedge ratios, regime filters etc.