Checking nancial markets via Benfords law1

Marco Corazza2 , Andrea Ellero3 , and Alberto Zorzi4

Abstract In this paper we compare the daily distribution of rst signicant digits of S&P 500s stock prices and returns against the Benfords law. In particular, the analysis is performed on 3067 days for 361 out of the 500 stocks. We obtain that the overall distribution of rst signicant digits roughly follows the Benfords law, conrming previous claims of the literature, and obtain that the majority of the daily distribution of return rst signicant digits follow Benfords law. Keywords Benfords law, S&P 500s stocks, prices, returns, chi-square.

Benfords law

For extensive collections of numerical data expressed in decimal form, the frequency of numbers which have d, with d = 1, 2, . . ., 9, as rst signicant digit is not 1 /9 , as one could expect, but strictly decreases as d increases (it is 0.301 if d = 1, 0.176 if d = 2, . . ., 0.045 if d = 9). As a consequence, the frequency is likely to be over 60% for numbers with most signicant digit 1, 2 or 3. The rst observation of this property traces back to S. Newcomb in 1881 (9), but a more precise description of it was given by F. Benford in 1938 (2). After investigation of a huge quantity of data, Benford guessed the following general formula for the probability that the rst signicant digit equals d: 1 . P (d) = log10 1 + d This formula is now called Benfords law. As mentioned, Benfords law can be observed in a variety of data collections. Examples are lake surface areas, river lengths, molecular weights of molecular compounds, street address numbers, and son on. Two common explanations for the origin of distributions which respect Benfords law are scale invariance and multiplicative process (11, 6). Using random probability measures, Hill (6) proved under fairly general conditions that if distributions are selected at random and random samples are taken from each of these distribution,
This research has been supported by Ca Foscari University of Venice, Italy. Department of Applied Mathematics, Ca Foscari University of Venice, Italy, and School for Advanced Studies in Venice Foundation, Venice, Italy. 3 Department of Applied Mathematics, Ca Foscari University of Venice, Italy. 4 I.T.I.S. V. Volterra, San Don` a di Piave, Italy.
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the signicant digits of the combined sample will converge to Benford distribution . For example, powers of a uniform(0, 1) random variable satisfy Benfords law in the limit (1, 7).

Applications of Benfords law to nancial data

Due to the widespread diusion of Benfords law, detecting a shunt from it becomes a tool for identifying data manipulations. For example, in this way the law was used in tax-fraud detection (10), fraudulent scientic and economic data ones (4, 5). Several attempts to exploit the universality of Benfords law in order to analyze nancial markets can be also found in literature. Ley (8) studied daily returns computed on Dow-Jones Industrial Average Index (DJIA) from 1900 to 1993 and on Standard and Poors Index (S&P) from 1926 to 1993. He found that the distribution of rst signicant digit of the returns roughly follows Benfords law. Similar results has been obtained for stock prices on single trading days (12). Benfords law was also used to discuss tests concerning the presence of psychological barriers and resistance levels in stock markets. In particular De Ceuster et al. (3) claim that dierences of the distribution of digits from uniformity are a natural phenomenon (Benfords law namely): as a consequence they nd no support for the psychological barriers hypothesis.

Do S&P 500s stocks satisfy Benfords law?

Ley (8) observed that despite the fact that chi-square goodness-of-t test on DJIA and S&P indexes suggest to reject the null hypothesis, this is due to the large number of observations he considers. In fact, the same kind of analysis performed only on 1983-1993 data suggests to accept the null. In the remainder of this section we briey present the main results of our investigation. As data we consider 3067 daily close prices and returns for 361 S&P 500s stocks, from August 14, 1995 to October 17, 2007. First, we compare the overall distributions of rst signicant digits of prices and returns against the Benfords law and the uniform distribution (gure 1) by means of the chi-square goodness-of-t test. In all the overall comparisons the null is rejected. Nevertheless, the rejection with respect to the uniform distribution is stronger and stronger than the rejection with respect to the Benfords law. In other terms, looking at chi-square as a distance, the empirical distributions are closer and closer to the Benfords law than the uniform distribution. In this sense we agree with Ley (8) following which the distributions of rst signicant digit of prices and returns roughly follow the Benfords law. Moreover, we notice that the distribution related to returns is signicantly closer to the Benfords law than the distribution

related to prices. Coherently with Pietronero et al. (11), this is the eect of the application of the multiplicative process by which returns are obtained by prices.
Price and Return Global Behavior: 08.14.1995 - 10.17.2007
0,35

0,30

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0,00 1 2 3 4 5 First digit 6 7 8 9

Figure 1: Overall distribution comparisons. Second, addressing our attention to returns, we day-by-day perform the same kind of comparisons against the Benfords law. Over 3067 days, the null is rejected 890 times ( 29.02%) using = 1%, and is rejected 1371 times ( 44.70%) using = 5% (gure 2). In particular, we notice that days or periods in which the null is strongly rejected are characterized by events5 that force the big majority of the stock returns to move in the same sirections. In this sense, Benfords law-based analyses can be able to detect anomalous behaviors in nancial markets. Third, again addressing our attention to returns, we notice that the length of sequences of consecutive daily rejections of the null is generally low, both with = 1% and with = 5% (gure 3). As, from the previous remark, rejection of the null can be associated to anomalous behaviors of nancial markets, the fact that the considered length is generally low can be interpreted as the capability of the S&P 500 market to come back to standard running in a relatively short time.
Like, for instance, the Twin Towers attack on September 11, 2001, or the Wall Street crash on February 27, 2007.
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# 100,00
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Chi-square Behavior (Returns): 08.14.1995 - 10.17.2007

Figure 2: Day-by-day calculated chi-square.

Sequences of Consequtive Rejections of the Null (Returns): 08.14.1995 - 10.17.2007

Length of sequences of consecutive rejections

Figure 3: Absolute frequencies of the length of sequences of consecutive daily rejections of the null.
Time
gu st u a 1 4, r A u y 1 19 9 5 g 4 F e us , 19 br t 14 96 ua , A u ry 1 19 9 6 g 4 F e us , 19 br t 14 97 ua ,1 r A u y 1 99 7 g 4 F e us , 19 br t 14 98 ua ,1 r A u y 1 99 8 g 4 F e us , 19 br t 14 99 ua , 1 A u ry 1 9 9 9 g 4 F e us , 20 br t 14 00 ua , A u ry 1 20 0 0 g 4 F e us , 20 br t 14 01 ua , A u ry 1 20 0 1 g 4 F e us , 20 br t 14 02 ua , A u ry 1 20 0 2 g 4 F e us , 20 br t 14 03 ua , A u ry 1 20 0 3 g 4 F e us , 20 t br 0 u a 1 4, 4 2 r A u y 1 00 4 g 4 F e us , 20 br t 14 05 ua ,2 r A u y 1 00 5 g 4 F e us , 20 br t 14 06 ua , A u ry 1 20 0 gu 4, 6 st 20 14 07 ,2 00 7

4
1% 5%

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15 Chi-square 5%

Some concluding remarks

To the best of our knowledge, several questions concerning the use of Benfords lawbased analyses in nancial market have to be again investigated. Among the various ones, we list the following: Are Benfords law-based analyses able to detect dierences (if any) among the sectors of a given nancial markets? Has this type of analyses predictive capability with respect to anomalous behaviors of nancial markets? Is it possible to use Benfords law-based analyses for implementing nancial trading systems?

References
[1] Adhikari A., Sarkar B., Distribution of most signicant digit in certain functions whose arguments are random variables, Sankhya Series B, 30 (1968) 4758. [2] Benford F., The law of anomalous numbers, Proceedings of the American Philosophical Society, 78 (1938) 551572. [3] De Ceuster M.J.K., Dhaene G., Schatteman T., On the hypothesis of psycological barrioers in stock markets and Benfords law, Journal of Empirical Finance, 5 (1998) 263279. [4] Diekmann A., Note the rst digit! Using Benfords law to detect fraudulent scientic data, Journal of Applied Statistics, 34 (2007) 321329. [5] G unnel S., T odter K-H., Does Benfords law hold in economic research and forecasting?, Discussion Paper Series 1: Economic Studies, Deutsche Bundesbank, 32/2007 (2007). [6] Hill T.P., A statistical derivation of the signicant-digit law, Statistical Science, 10 (1995) 354363. de la Rue T., From uniform distributions to Benfords law, Journal of [7] Janvresse E., Applied Probability, 41 (2004) 12031210. [8] Ley E., On the peculiar distribution of the U.S. stock indexes digits, The American Statistician, 50 (1996) 311313. [9] Newcomb S., Note on the frequency of use of the dierent digits in natural numbers, American Journal of Mathematics, 4 (1881) 3940. [10] Nigrini M., A taxpayer compliance application of Benfords law, The Journal of the American Taxation Association, Spring Issue (1996) 7291. [11] Pietronero L., Tossati E., Tossati V., Vespignani A., Explaining the uneven distribution of numbers in nature: the laws of Benford and Zipf, Phisica A, 293 (2001) 297304. [12] Zhipeng L., Lin C., Huajia W., Discussion on Benfords law and its applications, arXiv:math.ST/0408057 v2 4 Oct 2004 (2004).