medium · Quantitative Finance microstructure-arb
In the context of 'Pairs Trading', what is the fundamental requirement for the relationship between two stock prices?
- They must belong to the same sector and have identical dividend yields.
- They must have a correlation coefficient of exactly +1.0 over the last year.
- One stock must be a 'lead' indicator and the other a 'lag' indicator with a fixed time delay.
- They must be cointegrated, meaning a linear combination of their prices is a stationary process.
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