medium · Quantitative Finance
In a pairs trade, if the spread S = ln(P_A) - β ln(P_B) is used instead of the raw price difference, what is the primary advantage?
- It eliminates the need for a Dickey-Fuller test.
- The spread is interpreted in terms of percentage returns, which is more stable across different price levels.
- Logarithms make any non-stationary series stationary.
- The hedge ratio β will always be exactly 1.0 for log-prices.
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