Profitability of Pair Trading: A Case of Islamic Indices in Pakistan

Abstract

The pair trading strategy under portfolio construction is one of the profitable strategies. This is first ever study to observe the pair trading strategy using Islamic Index KSE firms. Distance approach is applied in this study by taking firms under KMI-30 Islamic index by using daily data from year January 1, 2012 to year December 31, 2019. These firms are divided into three subcategories, high-cap, mid-cap and low-cap. After formation of pairs, trading algorithm under various parameterizations is used to observe the profitability. The study concluded with positive and significant returns of top 3, 5, 7 and 10 pairs for each category. In addition, this study also witnessed with positive returns after risk adjustment of market factor for the top 3, 5, 7, and 10 pairs of Islamic index’s firms. These results are accordance with theories of mean revision and market neutrality. The study is contributing to the literature regarding the profitability of pair trading in Islamic Indices firms in Pakistan. Policy Implication for Islamic fund managers and investors is recommended.