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Abstract
Using a kinetic equation that is used to model turbulence (Physica A, 1985–1988, Physica D,
2001–2003), we redefine variables to model the time evolution of the foreign exchange rates of
three major currencies. We display live and predicted data for one period of trading in
October, 2003.
r 2004 Elsevier B.V. All rights reserved.
1. Introduction
where f 2 and f 1 are momentum distribution functions for the two states 2 and 1.
Here the momentum will be reinterpreted later as we please. We will specify the jump
Tel.: +41-22-310-1229; fax: +41-22-310-1229.
E-mail address: dtsny@verizon.net, amador.muriel@bluewin.ch (A. Muriel).
0378-4371/$ - see front matter r 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.physa.2004.06.114
ARTICLE IN PRESS
A. Muriel / Physica A 344 (2004) 190–193 191
operator J later. For the origin, solution and application of this equation we refer
the reader to the literature [2–4] from which it could be shown that the resulting time
evolution equations for f 2 is given by
" 2m m
X1
t=2 X m!
f2 ¼ e Gt
4j g2ðmjÞ g2j 2j
o J f 2 ð0Þ
m¼0
ð 2m Þ! j¼0
j!ðj mÞ!
2nþ1 n
X t=2
1 X n!
g 4j g2ðnjÞ g2j 2j
o J f 2 ð0Þ
n¼0
ð 2n þ 1 Þ! j¼0
j!ðj nÞ!
#
X ðt=2Þ
1 2nþ1 X n
n! j 2ðnjÞ 2j 2j
þ g12 4g go J f 1 ð0Þ ; ð2Þ
n¼0
ð2n þ 1Þ! j¼0 j!ðj nÞ!
where G ¼ g21 þ g12 ; g ¼ g21 g12 ; go2 ¼ g21 g12 . The corresponding solution for f 1 is
obtained by interchanging the subscripts 2 and 1. This will hold as well for other
subscripted variables.
t pffi 2 4g2o
g sinh ½g þ
2 ð1 DÞ4
p2 ð0Þ
pffi 2 4g2o
½g þ
ð1 DÞ4
3
t pffi 2 4g2o
g12 sinh ½g þ 7
2 ð1 D Þ4 7
þ p1 ð0Þ 2
7: ð4Þ
p ffi 4g 5
ð1 DÞ2 ½g2 þ o
4
ð1 D Þ
In principle, the variable p could be negative, but in our application, for short
intervals of time, and for positive averages in the initial condition, we do not have to
worry about this as justified by the demonstrated success of the algorithm below.
We now take a leap of interpretation and assume that hp2 i and hp1 i are the average
exchange rates of currency 2 and currency 1 relative to a stable currency 0 which
does not change too much over short periods. In this world there will be only three
major currencies, not too far from the truth sometimes. g21 is interpreted as the
transition rate from currency 2 to 1 and g12 is the transition rate from currency 1 to 2;
they could be positive or negative.
We may then convert Eq. (3) and its paired equation into difference equations and
use the following strategy: (1) Take two preceding times, time step 1, and time step 2,
with known currency exchange rates for each step. (2) Invert the two time evolution
equations to get the values of the transition rates from time step 1 to time step 2. (3)
Use these transition rates to predict the currency exchange rates for time step 3.
Repeat the process for the next time step, and so on, always recalculating the new
transition rates. In this way, one could always be ahead by one time step, predicting
the exchange rates at step 3, presumably allowing a trading strategy to yield profit.
One must of course choose the value of the fraction D and fine tune the predictive
scheme. The method is not quite Markoffian, but not completely non-Markoffian in
the traditional sense.
Without discussing the details, we illustrate one application of the above
algorithm to produce Fig. 1.
Fig. 1. Illustrative live United States dollar data from a period in October, 2003. The longer line is the
prediction line, while the short line is the live data. Time step 18 is the prediction for the next time step. In
each graph, the middle horizontal line is the mean of all the data, while the top horizontal line and the
bottom horizontal line delimit the spread used by a trading platform for the period during which the data
was collected. The above example is always accompanied by a similar graph for the euro, in USD, Euro
and Swiss franc trio. The two graphs may be accompanied by a recommendation to buy dollars using
Swiss francs and sell Euros for Swiss francs.
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A. Muriel / Physica A 344 (2004) 190–193 193
3. Comments
There are more currencies than this model can cope with. In the universe of three
currencies, we assume that the other currencies are simply background information
that violate any conservation principles that one may invoke about the value of
money in a zero-sum game. But any set of three currencies may be used, and it is
possible to develop a methodology that uses many sets of three currencies to cover
more ground. In addition, there will be redefined models for the short-time evolution
of the stock market.
That a model arising from turbulence research may be utilized as well for the so-
called turbulent market is a typical extension of physical theories to other fields,
sometimes, without justification. Such has been the character of several attempts to
use the Heisenberg Uncertainty Principle, or even collective behavior. Identifying or
redefining variables is the main difficulty. For example, in this model, why did we
choose to average the momentum instead of the kinetic energy? As it turns out, the
qualitative behavior of the model using any of these two variables are the same,
averaging the momentum variable is analytically easier, and the purist’s gain with the
use of energy, a measure of value, or money, is not justified by the performance of
that model. In the end, only success justifies the model once the leap of imagination
is made.
Acknowledgements
References
[1] J. Voit, The Statistical Mechanics of Financial Markets, Springer, New York, 2003.
[2] A. Muriel, Physica D 124 (1998) 225–247.
[3] A. Muriel, Physica A 304 (2002) 379.
[4] A. Muriel, Physica A 322 (2003) 139.