Relative Value Arbitrage Trigger Values?

[epon83]

Hey All,
I am looking at automating a rva strategy. Looking at cointegrated equity pairs.
Was wondering if people had suggestions on ways to optimize position entry levels.
An awful lot of papers just seem to pick an arbitrary number of standard deviations from the mean spread. Any suggestions?
Thanks

 

[Martinghoul]

Arguably, what you really want is an expected (ex-ante) Sharpe ratio for each proposed entry. If do this right, you should be able to estimate all the elements: the expected return (might include both the mean reversion and the financing components), the volatility (use historical) and the expected mean reversion horizon. This should allow you to compute an annualized Sharpe for each potential trade.

That's what I would do...