Augmented Dickey-Fuller test - useful?

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Augmented Dickey-Fuller test - useful?

posted Nov 30, 2013

Pairs trading seems to be a topic of interest recently on Quantopian. Does anyone have experience with cointegration tests, such as the augmented Dickey-Fuller test?

I've attached an example for:

context.stocks = [sid(8347), sid(23112)] # XOM & CVX

For this pair, the ADF test is not passed consistently at the 1% level, but it does pass for some 30 minute periods. For example, on 7/15:

2013-07-15PRINT2013-07-15 13:50:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:53:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:54:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:55:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:56:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:57:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:58:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 13:59:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 15:12:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 16:40:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 16:41:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 17:27:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 17:47:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 17:48:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 17:49:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 17:50:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 19:27:00+00:00 ADF test passed
2013-07-15PRINT2013-07-15 19:34:00+00:00 ADF test passed

Is this type of test (or a better one) normally part of a pairs trading algorithm, to ensure that the pair will likely revert?

Grant

2 responses

Patrick Langstrom

A good overview to stat arb (which is a new field to me, I'm not an expert) I think is this paper(s)

http://www.hughchristensen.co.uk/PaperDepository/papers/thesis/Burgess%20PhD%20Thesis%20-%20A%20Computational%20Methodology%20for%20Modelling%20the%20Dynamics%20of%20Statistical%20Arbitrage.pdf

search for dickey-fuller and he talks about its strengths and weaknesses and alternatives.

//Cheers

Thanks...Grant

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In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.