How Time-Varying Correlations May Affect Strategy Sharpe Ratios

Summary

The document introduces the Epps effect: measured correlations between two stocks can be lower at finer sampling intervals than at coarser ones. It poses a trading question about whether a strategy trading at the finer interval could benefit from this difference, and how that difference might relate to achievable Sharpe ratio.

No strategy, calculation, empirical evidence, or answer is provided. The prompt is useful as a research question, but it does not establish that the correlation gap can be traded profitably. Any Sharpe estimate would need a defined strategy and assumptions about returns, costs, execution, and risk.

Key ideas

• The Epps effect describes correlations that vary with the interval used to measure returns.
• The document asks whether finer-interval trading can exploit a gap between fine- and coarse-interval correlations.
• It provides no model, empirical findings, or Sharpe ratio calculation.

Tags

# Sharpe ratio of strategy exploiting correlations that vary by time interval


# Sharpe ratio of strategy exploiting correlations that vary by time interval












The Epps effect "is the phenomenon that the empirical correlation between the returns of two different stocks decreases with the length of the interval for which the price changes are measured" (Wikipedia). If you could trade two assets at the finer time scale, and they have a higher correlation of returns at the coarse than the fine time scale, what kind of Sharpe ratio can be achieved as a function of the difference in correlation of returns at the fine and coarse time scales?

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.