Sample interview questions: Can you explain the concept of pair trading and how it can be utilized in quantitative strategies?
Sample answer:
Concept of Pair Trading:
Pair trading is a quantitative strategy that seeks to capitalize on the relative price movements of two similar assets. It involves identifying a pair of assets that exhibit a high correlation but are temporarily mispriced.
Mechanism:
- Asset Selection: Identify a pair of assets (stocks, commodities, currencies, etc.) that have historically shown a strong correlation.
- Deviation Detection: Monitor the assets’ prices and identify periods when their prices diverge from their normal correlation. This deviation can indicate a mispricing opportunity.
- Hedge Position: To reduce risk, the strategy creates a hedged position by simultaneously buying one asset and selling the other.
- Value Reversion: The assumption is that the mispriced assets will eventually revert to their mean correlation. As they do, the profit is realized by unwinding the hedged position.
Benefits of Pair Trading:
- Relative Value Approach: Focuses on relative price movements, reducing exposure to market fluctuations. Read full answer
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