Epps Effect and the Signature of Short-Term Momentum Traders

TL;DR

This paper investigates a deviation from the typical Epps Effect in forex and cryptocurrency markets, identifying a local maximum in cross-correlation that suggests the influence of short-term momentum traders.

Contribution

It introduces the observation of a local maximum in cross-correlation functions, linking it to the activity of short-term momentum traders in FX and crypto markets.

Findings

Identified a sharp local maximum in cross-correlation at specific horizons.

Linked the anomaly to short-term momentum trading activity.

Extended understanding of correlation dynamics in non-traditional markets.

Abstract

It is a well-documented fact that the correlation function of the returns on two "related" assets is generally increasing as a function of the horizon $h$ of these returns. This phenomenon, termed the Epps Effect, holds true in a wide variety of markets, and there is a large body of literature devoted to its theoretical justification. Our focus here is to describe and understand a deviation to the Epps effect, observed in the context of the foreign exchange and cryptocurrency markets. Specifically, we document a sharp local maximum of the cross-correlation function of returns on the Euro EUR/USD and Bitcoin BTC/USD pairs as a function of $h$. Our claim is that this anomaly reveals the activity of short-term momentum traders.