Chaos, Solitons and Fractals 42 (2009) 1062–1067

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Chaos, Solitons and Fractals

journal homepage: www.elsevier.com/locate/chaos

Deterministic flow in phase space of exchange rates: Evidence of chaos

in filtered series of Turkish Lira–Dollar daily growth rates
Gürsan Çoban a,*, Ali H. Büyüklü b
a _
Division of Computational Science & Engineering, Institute of Informatics, Istanbul _
Technical University, Istanbul, Turkey
b _
Division of Applied Statistics, Department of Statistics, Yıldız Technical University, Istanbul, Turkey

a r t i c l e i n f o a b s t r a c t

Article history: This study aims to expose a possible dynamic structure and nonlinear relationship in
Accepted 26 February 2009 exchange rates. Specifically, the analysis derives on the filtered version of USDTRY daily
log returns, where TRY stands for the New Turkish Lira with respect to the US Dollar
(USD) between August 2001 and February 2007. A carefully applied projective filtering
methodology removed most of the noise contaminant. The computation of correlation
dimension and Largest Lyapunov Exponent (LLE) supported by the surrogate data testing
procedure showed that the nature of the governing dynamics of the filtered series has a
significantly different behavior from a stochastic system. All computations support the evi-
dence of deterministic chaos in the reconstructed phase space of the filtered USDTRY log
return series.
Ó 2009 Elsevier Ltd. All rights reserved.

1. Introduction

Chaotic analysis or nonlinear deterministic aspects of empirical data is an emerging field in time series analysis. The
acceptance of linear paradigm is that small causes lead to small effects. However, the optimistic expectation of analysts
towards linear approach for some kinds of data often fails to recover the main reason of change. That’s why, the ob-
served system may be an extension of nonlinear deterministic dynamical process, where the state of the process is de-
fined by clear equations but generates random-like outputs. It is the so-called chaotic processes characterized by
irregular and unpredictable behaviors that are nevertheless deterministic. Research in the analysis of chaotic time series
extend to a wide range of scientific areas such as atmospherics, dynamics of physiology, motion of astronomical systems
and also the dynamics of financial interactions [1,2]. For the last 20 years, a noteworthy deal of research related to the
chaotic analysis has been carried out in financial and economic fields. Most of the well known works in the early era of
financial studies seem to be focusing on a statistical point of view (quantified by the BDS approach) rather than the geo-
metrical structure peculiarities of phase space (see [3,4]). Widely known examples include the works of Hsieh [3] on
exchange rates and Scheinkman and LeBaron in [5] which have drawn a conclusion of strong nonlinearity by past depen-
dence where suitable nonlinear stochastic models are adequate. The relationship between chaotic analysis and classical
approaches towards financial series which are conceptualized on the martingale hypothesis of available long term predic-
tion, but impossibility of determining short term behavior was investigated by Frank and Stegnos in [6]. Similarly, by
applying the BDS test and calculating Lyapunov spectrum, Abhyankar et al. [7] found evidence for nonlinearity in equity
market indices but where GARCH type models are sufficient.
On the other hand, some new studies resulted in the existence of chaos by considering generally the largest Lyapunov
exponent (LLE). Bask [8] found evidence for a positive LLE in Swedish Krona exchange rate data via the approach of

* Corresponding author. Tel.: +90 212 4491662; fax: +90 212 4491706.
E-mail addresses: gcoban@be.itu.edu.tr, grscbn@yahoo.com (G. Çoban).

0960-0779/$ - see front matter Ó 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.chaos.2009.02.036
 G. Çoban, A.H. Büyüklü / Chaos, Solitons and Fractals 42 (2009) 1062–1067 1063

Rosenstein and by testing the sign by a statistical framework of moving block bootstrap methodology. Scarlat et al. [9] found
evidence for chaotic motion on the exchange rate series of Romanian ROL with respect to the American Dollar covering a
sample of 4002 daily observations where correlation dimension and LLE were mutually investigated. A very recent work
by Das and Das [10] also supports the existence of positive LLE in all investigated exchange rates with a similar algorithm
but deals with the predictability concept in calculating LLE where the surrogate data testing procedure was used to deter-
mine the nonlinearity. On the contrary, the comprehensive study of Schwartz and Yousefi [11] is not conclusive for positive
LLE’s in various exchange rates data, where also the same algorithm of Rosenstein for LLE was applied. Although the liter-
ature derived from real world time series of exchange rates does not seem to have conclusive findings, many new studies
have been currently in progress based on the theoretical results and real world observations.

2. Methodology

2.1. Phase space reconstruction and dynamical invariants

The first step in the analysis of chaotic time series is the reconstruction of a m-dimensional embedding space from ob-
served time series consisting of scalar values ðxt1 ; xt2 ; . . . ; xtN Þ. The basic assumption of the construction scheme is based
on an original unobservable attractor Q in the phase space where Q  M and governed by system dynamics f. A definition
of trajectory point movement, where f0 2 M, is given by ft ¼ f t ðf0 Þ. Function h which is defined on the original phase space
creates the observed real world time series measurement by xt ¼ hðft Þ; t ¼ t 1 ; t 2 . . . The main problem of embedding theory is
to reconstruct an attractor A  Rm that protects all the dynamical characteristics of the original attractor Q. The reconstruc-
tion theorem given by Takens [12] showed the existence of a transformation between the original and reconstructed spaces
via vector valued function A ¼ UðQ Þ. If M is a d-dimensional manifold, f be the flow of vector field F : M ! M, so the
Uf ;h ðfÞ : M ! Rd defined by Eq. (1) is an embedding for m P 2d þ 1 that carries all the geometrical properties (conjugate
topology) to the reconstructed attractor.
 T
Uf ;h ðfÞ ¼ hðfÞ; hðf s ðfÞÞ; hðf 2s ðfÞÞ; . . . hðf ðm1Þs ðfÞÞ ð1Þ

By considering Eq. (1), st ¼ ðxt ; xtþs ; xtþ2s ; . . . ; xtþðm1Þs ÞT may be used to reconstruct the attractor A  Rm . Here st is the embed-
ding space vector which is a set of selected scalars from time series measurement depending on the embedding parameters
which are the dimension of embedding ðmÞ and time delay ðsÞ. The delay time ðsÞ may be determined by calculating the first
minimum of the mutual information function [13]. Determination of the embedding dimension ðmÞ mostly focus on non-
crossing trajectory alignment in the embedding space by selecting some criteria. This is due to the existence of an inverse
transformation of U1 where embedding theorem guarantees that m P 2dimðAÞ þ 1 will suffice. The global false-nearest
neighbors (GFNN) method [14] and Cao’s method [15] are widely used.
Chaotic systems exhibit ‘sensitive dependence to initial conditions’ (SDIC). As a dynamical invariant the Lyapunov expo-
nents aims to quantify the average exponential growth rate for infinitely small initial errors at the beginning of the dynam-
ical process. A positive exponent is an evidence of SDIC and chaotic motion. If the problem is only to determine whether the
system has SDIC or not, non-Jacobian based approaches are sufficient. Two nearby trajectory vectors, fsk0 ; ski gNi¼0 , selected in a
distance of ksk0 ; ski k ¼ e turns into ksk0 þDk ; ski þDk k ¼ eekmax , after Dk iterations. Here, k0 þ Dk is the image of k0 after Dk itera-
tions which is outside the time span of the set U e ðsk0 Þ ¼ fski j ksk0 ; ski k < eg.
0 1
1 X N
1 X 
 sk


SðDk; e; mÞ ¼ ln @  0 þDk
 skþDk A ð2Þ
N k ¼1 U e ðsk0 Þ sk 2U e ðsk Þ
0 0

The average of logarithmic displacements ðSðDk; e; mÞÞ which are calculated from N vectors for different radiuses (defines
the set U e ) gives a straight line portion where the Largest Lyapunov Exponent (LLE) is the calculated slope of the portion
[16].
The SDIC has fundamental effects on attractor geometry in an unusual way when comparing with the Euclidian metric
concepts. Related to the self-similarity concept, the fractal dimension ðdÞ is supposed to be an invariant measure over the
attractor by following the point distributions in different length scales defined by a chosen hyper ball of radius e. A general
way used to calculate d is the correlation sum algorithm (Eq. (3)), which counts number of paired vectors which are closer
than e [17].

1 X
N X
Cðm; eÞ ¼ Hðe  ksj  sk kÞ ð3Þ
N pairs j¼m k<jw

On the other hand, it is difficult to estimate invariant properties of the noise-contaminated chaotic data due to the demol-
ished dynamics in different, relatively small length scales. Chaotic data is of special interest because one can distinguish
deterministic signal and noise. A practical way to approximate the deterministic components of the data by a manifold is
via locally linear projection which was applied in this study to remove noise from the original signal [1,18].
1064 G. Çoban, A.H. Büyüklü / Chaos, Solitons and Fractals 42 (2009) 1062–1067

3. Analysis of Turkish Lira–Dollar exchange rate

3.1. Data

In this work, the above-mentioned theoretical issues were investigated on the exchange rates of Turkish Lira (TRY) with
respect to the United States Dollar (USD). The data set which includes 1386 daily observation of closing rates value covering
the time interval of August 2001 and February 2007. Missing values sourced from weekends or holidays were ignored during
the analysis. Weak stationarity was tried to be realized by considering daily return rates, which are obtained by taking the
first logarithmic differences of the sequence, yt ¼ 100 lnðxt =xt1 Þ (Fig. 1).

3.2. Analysis

3.2.1. Noise reduction in embedding space

Reconstruction of the embedding space is derived by delay and dimension parameters. The delay time was determined by
the point where calculated mutual information reaches its first local minimum value of s ¼ 1. Cao approach points that the
E1d value has a location of knee at m ¼ 6—8 (Fig. 2). The exact position of the knee was calculated by a nonlinear function fit
applied on E1d  m curve, where the form of the function is E1d ¼ b  expðm  cÞ (b 2 Rþ ; c 2 R are both constants, m is the
dimension of embedding) [14]. These values were approximated by the Levenberg–Marquardt algorithm where
b ¼ 0:92954 and c ¼ 1:05658. The minimum value of absolute residuals of fit gives an estimate of the knee position at
m ¼ 7 (Fig. 2).
Initial analysis were performed on the original noisy series. The local slopes gathered from the computed correlation
sums have shown an estimated fractal dimension of D2  6:4 for the reconstructed attractor. Local slopes (dðeÞ) may also
2 2
be used to estimate the noise level through evaluating the Gaussian noise function of the form dnoise ðeÞ ¼ rp ffi e =4r Þ
eeffiffið
perf ðe=2rÞ where
r is the noise level (see [19] for detail). In many cases the noise level was determined in the interval 0:24 < r < 0:27. To
eliminate negative effects of noise, we applied a locally projective noise reduction by using the ghkss software module lo-
cated in the program package of TISEAN 2.1 [20]. To realize an accurate separation of noise and dynamic signal directions
locally, radius of neighborhood for projection should be chosen larger than the noise level where at least 50 points were
found [1]. The projection dimension q should be higher than the estimated fractal dimension, eventually q > 6. The number
of initial embedding dimensions Q to be projected was selected via some trial and set as an optimal level of Q ¼ 27. Three
iterations were successively applied due to the proposal of [20]. Calculated noise levels for both original and filtered signals
have shown that the noise level was reduced approximately one order of the initial magnitude (Fig. 3).

3.2.2. Dynamical invariants, nonlinearity and determinism

All chaotic analysis were applied on the noise free signal and results were evaluated only for the filtered USDTRY series.
Computations of the correlation sums were derived via d2 program module of TISEAN 2.1 [20]. The saturation of the corre-
lation exponent also gave an estimate of correlation dimension about D2  4:6 (Fig. 3). The local slopes calculated from the
same curves gave the scaling at 11 embedding dimensions which was verified as the correct dimensionality where stable
saturation exists on D2  m curve (Figs. 2 and 3).

0.60 a
Log Transformed. ln( xt)

0.55
0.50
0.45
0.40
0.35
0.30
0.25
0.20

2000 2001 2002 2003 2004 2005 2006

6
b
Return Rate100.ln( xt / x t-1)

-2

-4
2000 2001 2002 2003 2004 2005 2006
year

Fig. 1. (a) The natural log transformed series of USDTRY. (b) The first log difference of the series (2001–2007).
 G. Çoban, A.H. Büyüklü / Chaos, Solitons and Fractals 42 (2009) 1062–1067 1065

Fig. 2. Left: Determination of embedding dimension via Cao methodology where seven dimensions is a sufficient dimensionality of USDTRY. Right:
Correlation dimension versus embedding dimension (D2  m).

Fig. 3. Left: The noise level before and after the noise reduction scheme (dnoise ðeÞ ¼ dðm þ 1; eÞ  dðm; eÞ). Right: Local slopes (dðeÞ) of the correlation sums
for filtered USDTRY data.

e;mÞ
The LLE was calculated from the numerical derivation of SðDk; e; mÞ where kmax  @SðD@ k;Dk
for a sufficient interval of Dk iter-
ations. In the analysis, identified e values constructed the set U e ðsk0 Þ which has more than 40 neighbors. For all, computed LLE
is the mean value of local slopes gathered from the linear regime and converges to kmax ffi 0:05 (Fig. 4).
We applied surrogate data test procedure based on LLE following Das and Das [10] and also by the same software package
TSTOOL which is widely explained in [21]. The surrogate data are produced via shuffling observations in random order (RS)
and randomization of complex phase parameter of Fast Fourier Transformed (FFT) series [1,18,22]. Three hundred different

a b

Fig. 4. (a) Calculated SðDk; e; mÞ values via algorithm discussed in [16]. (b) Local slopes computed from the left diagram.
1066 G. Çoban, A.H. Büyüklü / Chaos, Solitons and Fractals 42 (2009) 1062–1067

Fig. 5. Representation of prediction error (pe) scores for both RS, FFT surrogates and filtered USDTRY data.

RS and FFT surrogate sequences were generated where LLE were computed for each series in order to constitute a sampling
for a hypothetical analysis. The exponential growth of prediction errors over iterations shows that the RS and FFT surrogates
do not have a stable linear regime whereas original sequence has a very clear linear part for 2 < Dk < 10 (Figs. 4 and 5). The
calculated LLE from this region is determined as kmax ¼ 0:0564  0:0011. In addition to these, the exact values of prediction
errors pe for pesurrogate , where 95% confidence boundary of both surrogate types do not intersect with original values, peoriginal
(Fig. 5). Thus, the hypothesis of inequality peoriginal –pesurrogate is significant. Consequently, the dissimilarity of pe  Dk scatter-
ing for randomized and original sequences depends on the dissimilarity of attractor dynamics, where surrogates behave in a
stochastic manner while original sequence is governed by the deterministic activity.

4. Discussion

Thoughts towards the possibility of a chaotic structure in exchange rate dynamics is not a new concept as it was widely
argued by many writers, some of whom are briefly mentioned in the introduction part of this study. Although the literature
derived from real world time series of exchange rates does not seem to have conclusive findings, many new studies have
been currently in progress based on the theoretical results and real world observations. The explained scheme and evaluated
results in this study focused on the log return series of USDTRY.
The main distinction of this analysis compared to the former ones is the noise reduction methodology which is not gen-
erally applied to financial time series. It is a fact that high level of noise may destroy the dynamic signal and cause interre-
lations mimicking stochastic nature.
The main finding of this study is the existence of determinism in the log return series of USDTRY. Despite having severe
shocks by external or internal economic or political events along with active interventions by the Central Bank of Turkey, in
this study, it is shown that the filtered subset of USDTRY log returns exhibits deterministic chaos properties in its own recon-
structed phase space with a correlation dimension of D2  4:6 and a LLE of kmax  0:05.

Acknowledgements

The authors gratefully thank Ercan Balaban from University of Edinburgh for his comments on the work. The authors also
_
gratefully thank Matjaz Perc (University of Maribor), Ilkay Boduroğlu, Kasım Koçak (Istanbul Technical University) and Rafi
Karagöl, for their indirect contributions to the work.

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