Much of what happens can conveniently be thought of as
random variation, but sometimes hidden within the
variation are important signals that could warn us of
problems or alert us to opportunities.
—Box on Quality and Discovery, G.E.P. Box

2.1 INTRODUCTION

The pair trading scheme was elaborated in several directions beginning with research pursued in Tartaglia’s group. As the analysis techniques used became more sophisticated and the models deployed more technical, so the sobriquet by which the discipline became known was elaborated. The term ‘‘statistical arbitrage’’ was first used in the early 1990s.

Statistical arbitrage approaches range from the vanilla pairs trading scheme of old to sophisticated, dynamic, nonlinear models employing techniques including neural networks,wavelets, fractals— just about any pattern matching technology from statistics, physics, and mathematics has been tried, tested, and in a lot of cases, abandoned. ...