Can Safety and Profitability Coexist? Performance Analysis of Pairs Trading among S&P 500 Stocks

Abstract

This study examines the effectiveness of pairs trading strategies in U.S. equity markets from 2005 to 2024, with a particular focus on how trading volume affects performance. Using a comprehensive approach that analyzes 270 distinct parameter combinations, various weighting methodologies, and realistic transaction cost scenarios, the research demonstrates that volume is a fundamental driver of pairs trading success. High-volume pairs consistently outperform low-volume pairs across all tested configurations and optimal parameters yielding Sharpe ratios well above 2 in the testing period. Contrary to efficient market expectations, strategy performance improved in recent years (2015-2024) compared to the earlier period (2005-2014). Transaction cost analysis reveals that while the strategy remains successful under institutional-level cost structures, trading commission fees impact performance more significantly than borrowing costs. The findings contribute to both theoretical understanding of market efficiency and practical implementation of statistical arbitrage strategies, suggesting that pairs trading continues to offer attractive risk-adjusted returns for sophisticated investors despite its widespread documentation in financial literature.