I am looking for some inputs on a pair trading strategy that I am trying to improve with some semi-fundamental input.
The basic idea is to use multiple linear regression to estimate the price of a stock ($Y$) based on fundamentals:
$$ Y(t) = \beta_0 + \beta_1*x_1(t) + \beta_2*x_2(t) + \cdots $$
Just to give you an idea of a case:
- $Y$ = Stock price, e.g. Starbucks
- $x_1$ = Market, e.g. S&P500
- $x_2$ = Coffe price
- $x_3$ = Competitor something..
- $x_4$ = Forex something..
My idea would be to only trade in the direction of the residual at the last date of the regression, meaning that if starbucks is at 55 and the regression gives a "fundamental" price at 60 I would only go long. And, since this is a part of a larger pair trading strategy I would short something else and include all the commonly used pair trading parameters.
After some extensive googling I have not been able to find any similar approaches. Anybody who has seen anything similar somewhere? Does it make any sense? Or is this just way off?