Pair Trading Lab Helpdesk & Forum
Pair Trading => Models, Algorithms & Approaches => Topic started by: andrew b on October 14, 2017, 10:11:07 pm

I read the following on the wiki: "For practical reasons to get meaningful signals from models, you typically also need to transform prices of one of legs (to "flip" the one of price streams). Pair Trading Lab now supports both features required. The transformation function is typically Pnew = A /Pold + B. These coefficients don't really matter, default values are A=1000, B = 0.5. You just want to transform prices in the way the result looks like a real price and it is not too low or too high. In 99% cases you can stick with these defaults."
If I understand correctly, the logic above would adjust and SPY/DIA analysis so that the price series used for assessing returns and hedge ratios would be: SPYmodified and DIA where SPYmodified=A/SPY + B.
Is the transformation and attempt to reduce large price scale differences between time series, e.g. backwards adjusted for splits VXX's close price in early 2009 was 107,089.9?
Could you add some more details on the price transformation  why and when it should be used and to which leg, if any, it should be applied? Thank you.

Hi Andrew,
price transformation is designed only to make possible trading of special pairs, where one of the leg is an inverse ETF...
More information here: https://wiki.pairtradinglab.com/wiki/Trading_Pairs_Based_on_Inverse_ETFs
It does not sense to apply it on a regular pair.
Karel