The Future of Sustainable Finance: AI-Driven Sustainable Pairs Trading in Market-Neutral Investing

Sustainable finance has emerged as a critical approach to directing investments and financial activities toward projects, businesses, and initiatives that align with environmental, social, and governance (ESG) principles. This approach aims to foster long-term economic growth while addressing global challenges such as climate change, social inequality, and resource depletion. A shifting landscape driven by sustainable economics and sustainable finance political agendas, along with a growing emphasis on ethical investment and banking, underscores the changing awareness among consumers and investors on financial activities. Pairs trading, traditionally a short-term, profit-oriented financial strategy, has recently found resonance with ESG principles, offering a novel avenue for sustainable financial practices. Investors are increasingly recognizing sustainable pairs trading as a means of generating profits while adhering to ethical and environmental considerations. This chapter provides an overview of pairs trading, encompassing both established practices and recent developments, with a focus on emerging trends such as artificial intelligence (AI) and machine learning (ML). While there is a growing interest from ethical investors, our research highlights that the development of sustainable AI pairs trading systems is still in its nascent stages. Nevertheless, the application of ML in sustainable pairs trading is swiftly progressing within academic circles and is attracting considerable attention from industry stakeholders. Our investigation reveals a growing trend in the adoption of sustainable pairs trading, mirroring the advancements in research within the field.