Pairs Trading and Basket Trading

What are pairs trading and basket trading?

Answer

Pairs trading: Here, using statistical tests/models we establish stationarity/mean reversion of of a spread between two assets. The mispricing is between the two assets and we trade accordingly.

Basket trading: Here, using statistical tests/models we establish stationarity/mean reversion of a portfolio spread. The mispricing is between one asset versus the rest of the basket and we trade accordingly.

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