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Proceedings Paper

Modeling the Epps effect of cross correlations in asset prices
Author(s): Bence Tóth; János Kertész
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Paper Abstract

We review the decomposition method of stock return cross-correlations, presented previously for studying the dependence of the correlation coefficient on the resolution of data (Epps effect). Through a toy model of random walk/Brownian motion and memoryless renewal process (i.e. Poisson point process) of observation times we show that in case of analytical treatability, by decomposing the correlations we get the exact result for the frequency dependence. We also demonstrate that our approach produces reasonable fitting of the dependence of correlations on the data resolution in case of empirical data. Our results indicate that the Epps phenomenon is a product of the finite time decay of lagged correlations of high resolution data, which does not scale with activity. The characteristic time is due to a human time scale, the time needed to react to news.

Paper Details

Date Published: 15 June 2007
PDF: 9 pages
Proc. SPIE 6601, Noise and Stochastics in Complex Systems and Finance, 66010J (15 June 2007); doi: 10.1117/12.727127
Show Author Affiliations
Bence Tóth, ISI Foundation (Italy)
Budapest Univ. of Technology and Economics (Hungary)
János Kertész, Budapest Univ. of Technology and Economics (Hungary)
Helsinki Univ. of Technology (Finland)

Published in SPIE Proceedings Vol. 6601:
Noise and Stochastics in Complex Systems and Finance
János Kertész; Stefan Bornholdt; Rosario N. Mantegna, Editor(s)

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