Anti-Persistent Values of the Hurst Exponent Anticipate Mean Reversion in Pairs Trading: The Cryptocurrencies Market as a Case Study

Abstract

Pairs trading is a short-term speculation trading strategy based on matching a long position with a short position in two assets in the hope that their prices will return to their historical equilibrium. In this paper, we focus on identifying opportunities where mean reversion will happen quickly, as the commission costs associated with keeping the positions open for an extended period of time can eliminate excess returns. To this end, we propose the use of the local Hurst exponent as a signal to open trades in the cryptocurrencies market. We conduct a natural experiment to show that the spread of pairs with anti-persistent values of Hurst revert to their mean significantly faster. Next, we verify that this effect is universal across pairs with different levels of co-movement. Finally, we back-test several pairs trading strategies that include H0.5 as an indicator and check that all of them result in profits. Hence, we conclude that the Hurst exponent represents a meaningful indicator to detect pairs trading opportunities in the cryptocurrencies market.

Keywords

• pairs trading
• efficient market
• time series
• cryptocurrencies
• Hurst
• prices