This paper aims to implement "structural changes detection procedure" in pairs trading algorithm and to show that the proposed approach outperforms the extant pair trading algorithm.Structural changes in pairs trading are defined in terms of changes in cointegrating factors and broken cointegration relationship. These changes are designed to test extant structural changes and unit root test methodologies.
The simulation finds that expanding the changes in structure, increasing the mean reverting process of spread, and extending the consecutive days of broken cointegration will increase the performances of the proposed algorithm. Empirical study results are also consistent those ofthe simulation studies. The proposed algorithm outperforms the extant algorithm relative to risk and return given that the cumulative profit/loss has a significant upward-slope with minimal variance.