Let's take a hypothetical strategy that works on a basket of etfs:
From these etfs 90 unique pairs can be made. Each pair is constructed as a market-neutral spread.
On each day, for each pair, calculate z-score based on 25-day standard deviation.
If z-score > threshold, go short, close next day
If z-score < -threshold go long, close next day
To keep it all simple, the calculation is done without any capital management (one can have up to 90 pairs in portfolio on each day) . Transaction costs are not taken into account either.
To put it simply, this strategy tracks one-day mean reverting nature of market neutral spreads.
Here are the results simulated for several thresholds:
No matter what threshold is used, the strategy is highly profitable in 2008, pretty good throuh 2009 and completely worthless from early 2010.
This is not the first time I came across this change in mean-reverting behavior in etfs. No matter what I've tried, I had no luck in finding a pairs trading strategy that would work on ETFs past 2010. My conclusion is that these types of simple stat-arb models just don't cut it any more.