Optimal Convergence Trading

Finance from University Library of Munich, Germany

Abstract: This article examines arbitrage investment in a mispriced asset when the mispricing follows the Ornstein-Uhlenbeck process and a credit- constrained investor maximizes a generalization of the Kelly criterion. The optimal differentiable and threshold policies are derived. The optimal differentiable policy is linear with respect to mispricing and risk-free in the long run. The optimal threshold policy calls for investing immediately when the mispricing is greater than zero with the investment amount inversely proportional to the risk aversion parameter. The investment is risky even in the long run. The results are consistent with the belief that credit-constrained arbitrageurs should be risk- neutral if they are to engage in convergence trading.

Keywords: arbitrage; leverage; investment strategy (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2004-01-14
New Economics Papers: this item is included in nep-fin
Note: Type of Document - pdf; prepared on Win2000; pages: 24; figures: 6
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0401/0401003.pdf (application/pdf)

Related works:
Working Paper: Optimal Convergence Trading (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0401003

Access Statistics for this paper

More papers in Finance from University Library of Munich, Germany
Bibliographic data for series maintained by EconWPA ().