hard · Quantitative Finance
A pairs trader defines the spread as S_t = ln(P_A,t) - β ln(P_B,t).
Why is the use of logarithms generally preferred in cointegration modeling for equities?
- It eliminates the need to test for unit roots in the residuals.
- It transforms the non-stationary I(1) price series into stationary I(0) series immediately.
- It ensures the cointegrating vector represents a constant percentage relationship rather than a nominal price gap.
- It increases the speed of adjustment κ by reducing the scale of the data.
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