Correlation emergence and the Epps effect in two coupled limit order books
Why stock correlations look stronger when you zoom out
When two stock markets trade together through connected orders, their price movements appear more correlated when measured over longer time periods—a phenomenon called the Epps effect. This study shows the effect emerges from three causes: traders using different clocks to react, delays in how coupling between markets responds, and the combination of both. The researchers derived mathematical formulas that predict correlation strength based on how you measure it.
Investors and regulators use price correlations to assess portfolio risk and market stability. If correlations shift depending on whether you look at second-by-second trades or daily data, it changes how much risk you think you're taking. Understanding what creates these shifts makes it possible to build more accurate risk models and detect when trading patterns signal real market stress versus technical measurement artifacts.