Home / Ideas / OU Optimal-Threshold Pairs (half-life-gated)
OU Optimal-Threshold Pairs (half-life-gated)
derive entry/exit bands analytically from the fitted mean-reversion process
Rather than a fixed ±2 z-score rule, fit an Ornstein-Uhlenbeck process to the spread and set entry, take-profit and stop-loss levels from the estimated reversion speed and transaction cost — the academic optimal double-stopping result. Half-life gating filters out slow, undead pairs. Distinct from prior z-score cointegration in both signal thresholds and sizing.
Universe
Cointegrated ETF pairs (Engle-Granger pre-screen) retained only when OU half-life sits in a 5–30 trading-day window; e.g. sector/commodity/rates ETF pairs from a liquid candidate list.
How it works
Estimate OU parameters on a 120-day window, compute optimal entry/exit intervals and a stop below entry; trade the spread with a hard holding cap of ~2× half-life, sizing scaled by reversion speed (faster reversion = larger size).
Expected performance
Research-derived Sharpe estimate: 0.6–1.1. optimized exit rules reported to improve profitability and cut turnover versus naive bands).
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/signalchain OU-process pairs trading, analytic optimal entry/exit/stop from fitted mean-reversion speed, half-life-gated 5-30 day ETF pairs, speed-scaled sizing
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Research & sources
- arxiv.org — arxiv.org
- hudsonthames.org — hudsonthames.org
- interactivebrokers.com — interactivebrokers.com
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