Which method evaluates and compares risks associated with paired investments?

Pairs trade analysis is a method specifically designed to evaluate and compare risks associated with two paired investments, typically by identifying long and short positions in correlated assets. The primary goal of this method is to capitalize on the relative price movements between the two assets while controlling for market risk. By assessing the historical relationship between the two investments, the analysis quantifies the risk of one asset underperforming in relation to the other.

In pairs trading, traders often look for divergence between two correlated stocks or securities in order to set up a position that is market-neutral, thus minimizing systematic risk. This direct comparison allows investors to focus on the relative risk profile of the paired assets, making it a suitable tool for strategic investment decisions based on risk return characteristics.

While scenario analysis evaluates potential outcomes across a range of possible future states, and mean-variance optimization seeks the best risk-return profile among a set of investments, these methods do not specifically focus on paired investments in the same manner. Similarly, performance benchmarking measures investment performance against a standard but does not inherently compare the risks of two specific investments in the same context as pairs trade analysis does.