empirical research often concentrates on the average economic in-
dexes, such as the S&P 500. Averaging over a large number of
companies certainly smoothes noise. Yet, the composition of these
indicators is dynamic: Companies may be added to or dropped from
indexes, and the company’s contribution to the economic index usu-
ally depends on its ever-changing market capitalization.
Foreign exchange rates are another object frequently used in empir-
ical research.
Unfortunately, many of the findings accumulated during
the 1990s have become somewhat irrelevant, as several European cur-
rencies ceased to exist after the birth of the Euro in 1999. In any case, the
foreign exchange rates, being a measure of relative currency strength,
may have statistical features that differ among themselves and in com-
parison with the economic indicators of single countries.
Another problem is data granularity. Low granularity may under-
estimate the contributions of market rallies and crashes. On the other
hand, high-frequency data are extremely noisy. Hence, one may
expect that universal properties of financial time series (if any exist)
have both short-range and long-range time limitations.
The current theoretical framework might be too simplistic to ac-
curately describe the real world. Yet, important advances in under-
standing of scaling in finance have been made in recent years. In the
next section, the asymptotic power laws that may be recovered from
the financial time series are discussed. In Section 8.3, the recent
developments including the multifractal approach are outlined.
Theimportance of long-rangedependencies in thefinancialtime series
was shown first by B. Mandelbrot [6]. Using the R/S analysis (see Section
6.1), Mandelbrot and others have found multiple deviations of the
empirical probability distributions from the normal distribution [7].
Early research of universality in the financial time series [6] was
based on the stable distributions (see Section 3.3). This approach,
however, has fallen out of favor because the stable distributions have
infinite volatility, which is unacceptable for many financial applica-
tions [8]. The truncated Levy flights that satisfy the requirement for
finite volatility have been used as a way around this problem [2, 9, 10].
One disadvantage of the truncated Levy flights is that the truncating
88 Scaling in Financial Time Series
distance yields an additional fitting parameter. More importantly,
the recent research by H. Stanley and others indicates that the asymp-
totic probability distributions of several typical financial time series
resemble the power law with the index a close to three [11–13]. This
means that the probability distributions examined by Stanley’s team
are not stable at all (recall that the stable distributions satisfy the
condition 0 < a 2). Let us provide more details about these interest-
ing findings.
In [11], returns of the S&P 500 index were studied for the period
1984–1996 with the time scales Dt varying from 1 minute to 1 month.
It was found that the probability distributions at Dt < 4 days were
consistent with the power-law asymptotic behavior with the index
a 3. At Dt > 4 days, the distributions slowly converge to the
normal distribution. Similar results were obtained for daily returns
of the NIKKEI index and the Hang-Seng index. These results are
complemented by another work [12] where the returns of several
thousand U.S. companies were analyzed for Dt in the range from
five minutes to about four years. It was found that the returns of
individual companies at Dt < 16 days are also described with the
power-law distribution having the index a 3. At longer Dt, the
probability distributions slowly approach the normal form. It was
also shown that the probability distributions of the S&P 500 index
and of individual companies have the same asymptotic behavior due
to the strong cross-correlations of the companies’ returns. When these
cross-correlations were destroyed with randomization of the time
series, the probability distributions converged to normal at a much
faster pace.
The theoretical model offered in [13] may provide some explan-
ation to the power-law distribution of returns with the index a 3.
This model is based on two observations: (a) the distribution of the
trading volumes obeys the power law with an index of about 1.5; and
(b) the distribution of the number of trades is a power law with an
index of about three (in fact, it is close to 3.4). Two assumptions were
made to derive the index a of three. First, it was assumed that the
price movements were caused primarily by the activity of large mutual
funds whose size distribution is the power law with index of one (so-
called Zipf’s law [4]). In addition, it was assumed that the mutual fund
managers trade in an optimal way.
Scaling in Financial Time Series 89

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