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Cointegration (Pairs Trading)

Two non-stationary prices whose linear combo is stationary.

Two stocks can each wander randomly yet move together long-term — their spread is mean-reverting. Pairs trading shorts the rich leg and buys the cheap leg, betting the spread closes. Tested with the Engle–Granger or Johansen procedure.

Engle–Granger: regress A on B, test residuals for stationarity (ADF)

from statsmodels.tsa.stattools import coint
score, pvalue, _ = coint(asset_a, asset_b)
# pvalue < 0.05  ⇒  cointegrated, tradeable pair