A colleague had asked if I could help develop a multi-factor cointegration model for the Canadian bond market on daily or more frequent sampling, based on a variety of market data and fundamental factors. I had not developed a model like this before and was skeptical that could produce a useful result short of some man years of research.
To my surprise, found a very high probability model with 95% R-squared values and very high significance in a variety of tests. Now have a variety of models based on it depending on all or some of the below:
- US 3m rates
- US 2y swap rates
- S&P 500
- S&P / TSE Composite
- Shanghai Composite index (SSE 300)
- CAD/USD fx rate
- CAD 5Y liquid bond
- Surprise Index
With the 2 variable cointegration, one is simply trading mean reversion on the spread between one security and another. With a multivariate cointegration, one trades a long or short basket against the cointegrating security.