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Correlation emergence and the Epps effect in two coupled limit order books

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  • Chris Angstmann
  • Tim Gebbie

Abstract

We give a unified analytic account of correlation emergence and the Epps effect in two coupled limit order books. The model starts from a discrete random-walk description of order flow with creation, cancellation and diffusion. A pair-trader coupling between the books is introduced at the level of order creation. We clarify how the discrete model reduces to coupled reaction--diffusion equations with a moving reaction boundary defining the transaction price. Using a regularised local-response representation of the coupling, we derive approximate closed-form expressions for realised correlations as a function of aggregation time. Here the Epps effect is shown to arise from three distinct mechanisms: asynchronous event clocks (subordination), finite coupling response times, and their combination.

Suggested Citation

  • Chris Angstmann & Tim Gebbie, 2026. "Correlation emergence and the Epps effect in two coupled limit order books," Papers 2606.14182, arXiv.org.
    • Handle: RePEc:arx:papers:2606.14182
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    File URL: http://arxiv.org/pdf/2606.14182
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