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Optimal Convergence Trading

Author

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  • Vladislav Kargin
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.

Suggested Citation

  • Vladislav Kargin, 2003. "Optimal Convergence Trading," Papers math/0302104, arXiv.org, revised Aug 2003.
    • Handle: RePEc:arx:papers:math/0302104
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    References listed on IDEAS

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    Cited by:

    1. Yingdong Lv & Bernhard K. Meister, 2010. "Implication Of The Kelly Criterion For Multi-Dimensional Processes," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(01), pages 93-112.
    2. Yingdong Lv & Bernhard K. Meister, 2009. "Application of the Kelly Criterion to Ornstein-Uhlenbeck Processes," Papers 0903.2910, arXiv.org.

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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