Explanation

Option A is correct because relative valuation models are ideal for pairs trading strategies.

Why relative valuation models work best for pairs trading:

• Comparability: Relative models compare companies within the same industry/sector
• Mean reversion: Pairs trading relies on the assumption that valuation ratios will revert to historical norms
• Market-neutral: The strategy aims to profit from relative mispricing regardless of overall market direction

Other models are less suitable:

• Asset-based models: Focus on liquidation value, not relative performance
• Free cash flow models: Focus on absolute intrinsic value, not relative valuation differences

Pairs trading typically uses metrics like P/E ratios, P/B ratios, or other multiples to identify temporarily mispriced pairs.