By Jeff Pietsch
A "cointegrated" security pair is one for which the return series are correlated in a mean-reverting manner. Thus, a strongly cointegrated pair can make a terrific long-short trade after a period of performance divergence.
As described earlier in the year, the way the intuition behind cointegration was first related to me, was to imagine a man walking his dog. The man and dog may seemingly move independently and in different directions for a while, but the leash ensures that they will eventually cross paths.
With the recent explosion of ETFs, I thought I would update this year's earlier post on the topic. Among a diversified pool of about 160 tracked ETFs, here are the top ten pairings for the last 250 trading days against the Standard & Poors 500 Spiders (NYSEARCA:SPY) and iShares MSCI EAFE (Foreign) Index (NYSEARCA:EFA), respectively, as ranked by the Augmented Dickey-Fuller (ADF) Unit Root Test.
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Cointegration ADF hypothesis test results versus the SPY, updated monthly, will be provided in the forthcoming ETF Rewind nightly newsletter. For more on pairs trading, see this post from the Market Rewind blog vaults.