Test of Persistence in Indian Stock Market:

A Rescaled Range Analysis

Sibanjan Mishra* and Bimal Chandra Mishra**

While most traditional science deals with supposedly predictable phenomena like gravity, electricity, or chemical
reactions, Chaos Theory deals with nonlinear things that are effectively impossible to predict or control, like turbulence,
weather, the stock market, our brain states, and so on. Hence, such processes focus on non-randomness, nonlinearity
and chaotic characteristics. In recent times, such nonlinear dynamics and chaotic dynamics have augmented in the
field of financial analysis. This paper studies the extent to which the daily return data from the Indian Stock Exchange
indices (Nifty and Sensex) exhibit these nonlinear, non-random characteristics. The Hurst exponent in rescaled
range analysis rejects the hypothesis that the index return series are random, independent and identically distributed.
The BDS test provides evidence for nonlinearity. The results confirm the existence of fractal structure (i.e., self-
similarity across different scales) in Nifty and Sensex. Basing on these results, technical analysis theory, i.e., Elliot
Wave Theory, can also be justifiable.

Introduction
It is difficult to tell from the data whether an observed process is random or chaotic, because
in practice no time series consists of a pure ‘signal’. Thus, any real time series, even if typically
deterministic, contains some randomness. Recent research impetus in the capital market
arena is to develop theories that are capable of explaining the random movements in asset
prices and returns. An explanation of such stock return behavior has drawn on the field of
nonlinear dynamics. Nonlinear dynamics is ideally explained by the Chaos Theory which is
based on the assumption that the underlying system is a nonlinear and a deterministic
process.
Chaotic systems have attracted the attention of many researchers from different fields
because of two reasons. First, it is relatively easy to tune the parameters of dynamic economic
models so that they generate complex dynamics (Benhabib and Nishimura, 1979). Second, it
is easy to construct examples of nonlinear dynamics that appear random in linear tests (Sakai
and Tokumaru, 1980). The existence of chaotic behaviors can be detected by the following
indications:
• Chaotic process is not random but Independent and Identically Distributed (IID).
• Chaotic process is nonlinear.

* Assistant Professor, Xavier University, Bhubaneswar, Odisha, India; and is the corresponding author.
E-mail: sibanjan@gmail.com
** Reader (Retd.), Orissa Education Service-I (OES), Government of Odisha, Odisha, India.
E-mail: bimalmishra1955@yahoo.in

© 2015
Test IUP. All Rights
of Persistence Reserved.
in Indian Stock Market: A Rescaled Range Analysis 5
 • Chaotic process is a deterministic process which retains its dimensionality when
it is placed in a higher embedding dimension.
• Chaotic process is sensitive to initial conditions.
As the Efficient Market Hypothesis (EMH) and the random walk model fail to capture
the behavior in many stock markets, some researchers like Brock et al. (1991); and Hsieh
(1991) and (1993) have pointed out that nonlinear dynamics is appropriate to explain the
complexity in many stock returns series. Fama (1965) admits that linear modeling techniques
are limited in capturing the complicated patterns which chartists claim to see in stock prices.
Papaioannou and Karytinos (1995) indicated that a non-efficient market is very suitable for
chaotic analysis, because the number of underlying moving forces (degree of freedoms in
statistical terms) is fewer than those in developed and more efficient markets.
Thus, the objective of this paper is to examine whether the time series of the indices
returns in Indian stock exchanges is generated by nonlinear dynamical system. If so, the
predictive ability of the system is strongly limited, especially for long-run predictions.
Furthermore, we focus on examining whether chaos theory can capture the complex and
random behavior that may not be obtained or derived from a stochastic approach or the
traditional random walk model.

Literature Review
Test of persistence and its presence in the financial time series has been discussed in several
past and recent papers. Peters (1992) shows that the S&P 500 Index monthly return series
has long-term dependence and a cycle length of 48 months. Peters (1994) finds that the same
phenomenon appears in Dow Jones Industrial Index. Hampton (1996) reports a strong and
continuing dependence on the S&P 500 returns series before the market crashed in 1987 and
1990. Opong et al. (1999) find the same evidence of non-IID in London Financial Times
Stock Exchange (FTSE) returns series. Same results are also reported in the other European
and some emerging markets. Errunza et al. (1994) find evidence of fractal dynamics in equity
returns of Germany, Japan, Argentina, Brazil, Chile, India and Mexico. Papaioannou and
Karytinos (1995) find evidence of dependence in the Athens Stock Market Index returns
series. Lin (1997) also reports same evidence of nonlinear dependence in the Dow Jones
Industrial Average return series. Dependence is more significant in 1995 when the US equity
markets made the start of a strong bull run. Pandey et al. (1997) report evidence of nonlinear
dependence in the index returns of Hong Kong, Japan and the US.
Regarding the emerging markets, Hamill and Opong (1997) report nonlinear dependence
in Irish stock returns, while Papaioannou and Karytinos (1995) find that the Athens Stock
Exchange Index returns are also nonlinearly dependent. Peters (1994), Vandewalle et al.
(1997), Carbone et al. (2004), Grech and Mazur (2004), Di Matteo et al. (2005), Di Matteo
(2007), Alvarez-Ramirez et al. (2008), Czarnecki et al. (2008) and Matos et al. (2008) estimate
Hurst exponent H with the theoretical value for an independent process of 0.5. Hurst
exponent of 0.5 indicates two possible processes: either independent (Beran, 1994) or short-

6 The IUP Journal of Applied Finance, Vol. 21, No. 4, 2015

range dependent process (Lillo and Farmer, 2004). If H > 0.5, the process has significantly
positive correlations at all lags and is said to be persistent (Mandelbrot and van Ness, 1968).
On the other hand, if H < 0.5, it has significantly negative correlations at all lags and the
process is said to be anti-persistent (Barkoulas et al., 2000). However, Lo (1991) criticizes the
statistical R/S test used by Mandelbrot and Green and Fielitz on the ground that after
accounting for short-range dependence, it might yield a different result and propose a modified
R/S test statistic. However, Willinger et al. (1999) indicate that the modified R/S test shows
a bias towards rejection of long-range dependence by rejecting the null hypothesis of short
memory when the degree of long memory is not very high. Since financial data typically
displays low degree of long memory, they claim that the result of Lo (1991) may not be
conclusive.
Singh and Dey (2000) examine the efficacy of stock market using the rescaled range
analysis and Hurst’s exponent, Fractal dimensions and the Lyapunov exponents. The results
show that the stock market has nonlinearities. Tran Van Quang (2005) analyzes the Czech
equity price index using the Fractal Market Hypothesis. The results reveal that the price
changes on Czech equity market did not follow a random walk and the market was far behind
efficient. Assaf (2006) tests the stock market of Kuwait having long memory in the monthly
returns, absolute returns, squared returns and modified long squared returns using the analysis
of rescaled range statistic and rescale variance statistic. Wen-Cheong Chin et al. (2007)
investigate the volatility measurement of Kuala Lumpur Stock Exchange index prices.
Autoregressive Fractionally Integrated Moving Average model and Heterogeneous
Autoregressive are used to find out the long memory and volatility in the market. The results
show that long memories exhibited in the market due to significant relation between news
and volatility.
Gayathri and Selvam (2011a) study the efficiency of Fractal Market Hypothesis in the
Indian stock market. According to this study, any new information would be immediately
and fully reflected in prices and stock returns of equity and also the short-term and long-term
trade follow technical information and fundamental information, respectively. Gayathri and
Selvam (2011b) analyze the Fractal Structure in the National Stock Exchange of India to
examine the long-range dependence of daily returns of Nifty. The results confirmed that
Indian stock market were not random and rejected the EMH for Indian stock markets during
the study period. Murugesan et al. (2011) test the Fractal Structure Analysis in the Indian
stock market. The study analyzes the Fractal Structure in Sensex returns and finds that the
trend occasionally followed the random walk initially. Thus, the study finds that fractal
structure existed in the BSE Sensex.
In recent literature, the value of Hurst exponent is estimated by various methods such as
Detrended Fluctuation Analysis (DFA), Rescaled Range (R/S) analysis, Modified Rescaled
Range (MR/S) analysis, wavelet analysis, and so on. Among them, DFA is a common way
which was proposed by Peng in 1994 in order to study the correlation between DNA bases
and sort order. This method overcomes the shortcomings of R/S as it can effectively estimate

Test of Persistence in Indian Stock Market: A Rescaled Range Analysis 7

the scaling exponent and describe long-range correlation of the time series. Hence, DFA is
rapidly and broadly applied in many different fields, for instance, DNA sequences, equipment
failures, stock market, physics, meteorology, and geology. If the order of polynomial fitting in
detrended process is m, it is denoted as DFA m. Sequences can be used to describe the natural
and social phenomena; for example, price fluctuation of stock market, fluctuation of heart
rates and brain wave, and the noise in electronic components, natural landscapes.
All the authors agreed that identification of persistence is very significant in at least two
senses: (a) the time span and strength of persistence will be an important input for investment
decisions regarding investment horizons and composition of portfolios; and (b) prediction
of price movements will be improved. Thus, it has become important to test the persistence
in the Indian market taking the stock market data for the last one decade during which
substantial regulatory changes have taken place and the market practices have changed
dramatically.

Methodology
Rescaled Range (R/S) Analysis
Whether the stock price movement follows a random walk or not can be detected by the
rescaled range analysis or R/S analysis. The R/S analysis is an ideal statistical tool for analyzing
the occurrence of rare events and is robust to possible nonlinear process that normality
assumption may not be needed. The result of the R/S analysis is the Hurst exponent, which
is a measure of the bias or trend in a time series.
N
The dataset is portioned into a sequential non-overlapping blocks, as A  , where A is
n
the number of partition, N is the amount of data in the series and n is the amount of data in
each partition. The data in each block is x( t,a ). The mean of x ( t ,a ) ( x a ) for the ath block of data
is defined as

n
1

x a    x t,a
 n  t 1
...(1)

The accumulated differences, X a , between each x ( t ,a ) and the mean for each block of
data, x a is given by

n
Xa  ( x
t 1
( t ,a )  xa ) ...(2)

The range, Ra, is defined as the difference between the minimum and the maximum
cumulative deviation for each block of data, given by
Ra = max (Xa) – min (Xa) ...(3)
The standard deviation, Sa, for each block of data is determined, given by

8 The IUP Journal of Applied Finance, Vol. 21, No. 4, 2015

 n

( x
t 1
( t ,a )  x a )2
...(4)
Sa 
n

The average rescaled range (R/S)n for length n, which is computed for different lengths
until n = N/2, is defined as

A
 1  R 
( R / S)n     a 
 A  a 1  Sa


...(5)

The final step is to apply an OLS regression with ln(R/S)n as the dependent variable and
ln (n) as the independent variable through the plot. The regression coefficient of the regression
Equation (6) provides the estimation of H, the Hurst exponent:
ln(R/S)n = H . ln(n) + C ...(6)
The value of H can be interpreted in the following ways:
• H = 0.50 denotes a random and statistically independent (uncorrelated) series—
a random walk. The present does not influence the future. The correlation
coefficient is 0. Its probability density function is normal. Such process increases
with the square root of time.
• 0.50 < H  1.00 denotes a ‘persistent’ or trend-reinforcing series. That is, the data
contains long-term memory and has a tendency to follow the current trend in the
next period. This process is said to be mean-averting.
• H < 0.50 denotes an ‘anti-persistent’ or ergodic series. That is, the data has a
tendency to reverse the current trend. This process is said to be mean-reverting.

BDS Test
BDS test was suggested by Brock et al. (1987). This hypothesis testing uses the test statistics
in which the mechanism is based on the correlation integrals. The BDS test is a powerful tool
for detecting serial dependence in time series. It tests the null hypothesis of IID against an
unspecified alternative. The null and alternative hypotheses are as follows:
H0: The data are Independently and Identically Distributed (IID).
H1: The data are not IID; this implies that there may be some serial dependence. If the linear
dependence has been removed in the time series, the serial dependence is thus nonlinear.
However, BDS test is unable to distinguish between nonlinear deterministic chaos and
nonlinear stochastic systems. BDS test cannot test chaos directly but only nonlinearity,
provided that any linear dependence has been removed from the data (e.g., using traditional
ARIMA-type models or taking a first difference of natural logarithms). Nevertheless, since a
nonlinear process is one of the indications of chaos, we may use the BDS test to detect such
indication. The BDS test statistics is defined by:

Test of Persistence in Indian Stock Market: A Rescaled Range Analysis 9

 N
BDS ,m  (C ,m  [C ,1]m ) ...(7)
V ,m

This test will be repeated at different values of ‘’ and ‘m’. Lin (1997) suggested that the

appropriate values of range from 0.5 to 2. Brock et al. (1987) pointed out the appropriate

values of m to be between 2 and 5.

Detrended Fluctuation Analysis

Detrended Fluctuation Analysis (DFA) was first proposed by Peng et al. (1994) while
examining the series of DNA nucleotides. Compared to the R/S analysis examined above,
DFA uses different measure of dispersion-squared fluctuations around trend of the signal. As
DFA is based on detrending of the sub-periods, it can be used for non-stationary time series.
Starting steps of the procedure are the same as the ones of R/S analysis as the whole series
is divided into non-overlapping periods of length n which is again set on the same basis as in
the mentioned procedure and the series profile is constructed. The following steps are based
on Grech and Mazur (2005). Polynomial fit Xn.l of the profile is estimated for each sub-period
In. The choice of order l of the polynomial is rather a rule of thumb but is mostly set as the first
or the second order polynomial trend as higher orders do not add any significant information
(Vandewalle et al., 1997). The procedure is then labeled as DFA-0, DFA-1 and DFA-2 according
to an order of the filtering trend (Hu et al., 2001). We stick to the linear trend filtering and
thus use DFA-1 in the paper.
A detrended signal Yn.l is then constructed as

Yn,l(t)  X(t)  X n,l ...(8)

2
Fluctuation FDFA ( n, l) which is defined as

n
1
2
FDFA ( n, l) 
n Y
t 1
2
n ,l ( t ) ...(9)

Scales as
2
FDFA ( n, l) ~ cn 2H(l ) ...(10)

where c is a constant independent of n (Weron, 2002). We again run an ordinary least squares
regression on logarithms of (10) and estimate Hurst exponent H(l) for set l-degree of
polynomial trend in the same way as for R/S as
2
log b FDFA ( n, l) ~ log b c  H(l)log b n

DFA can be adjusted and various filtering functions Xn,l can be used.

10 The IUP Journal of Applied Finance, Vol. 21, No. 4, 2015

Data
The dataset consists of daily natural logarithmic returns of Nifty (NSE) and Sensex (BSE).
The data covers a 9-year period from May 2, 2003 to March 22, 2012, consisting of 2,201
observations. The daily returns were calculated as the change in the logarithm of closing
stock market indices of successive days:
x t  ln( Pt )  ln( Pt 1 ) ...(11)

Results and Discussion

Descriptive Statistics
Table 1 reveals the descriptive statistics for Sensex Table 1: Summary Statistics: Daily
(BSE) and Nifty (NSE) returns for a 9-year period Sensex and Nifty Indices Returns
from May 2003 to March 2012. The negative value
Statistics Sensex Nifty
of skewness –0.10245 for Sensex and –0.25899 for
Nifty indicate that the distributions are Sample Size 2200 2200
asymmetrical. Negative skewness is characterized Mean 0.000789 0.000783
by the degree of asymmetry of a distribution around Median 0.001456 0.00154
its mean. The Kurtosis at 10.19 and 11.22 for Sensex
SD 0.017145 0.017288
and Nifty, respectively, was leptokurtic. It indicates
that the investors could earn extremely positive Skewness –0.10245 –0.25899
outcomes in both the indices during the study period. Kurtosis 10.19143 11.22178
Maximum 0.1599 0.163343
Rescaled Range (R/S) Analysis
Tables 2 and 3 present the results of the R/S analysis Minimum –0.11809 –0.13054
of the Sensex and Nifty daily returns. Table 3 shows that the Hurst exponents for daily
Sensex and Nifty daily returns series are 0.634 and 0.626, respectively. The high R2 (95.9%
and 95.6% in both, respectively) and low standard error of estimate (0.181 and 0.185,
respectively) illustrate the goodness of fit of the regression model for estimation.
The values of H exponent for both the return series is greater than 0.5, which signifies
that the series is not generated by purely random process. Persistence exists in both the
series, that means if the prices have been up during the current period, there is a probability
of 63.4% and 62.6% for Sensex and Nifty, respectively, that they are likely to be up during the
subsequent period. Such kind of persistent trend is said to be biased random process or
fractional Brownian motion. The time series is persistent, implying that the investors’
interpretation of events is not reflected in the price immediately. Thus, the R/S test confirms
chaotic behavior characteristics of non-randomness, sensitive to initial conditions and
deterministic process for both the Indian indices.

Tests of Nonlinearity: BDS Test

To test the presence of nonlinearity, the logarithmic index returns series in both stock markets
is subject to BDS test. The linear dependence on the original index time series has already
been removed by taking a first difference of natural logarithm.

Test of Persistence in Indian Stock Market: A Rescaled Range Analysis 11

 Table 2: R/S Analysis Results – Daily Sensex and Nifty Indices Returns
Sensex Nifty
n ln(n) R/S ln(R/S) V-Stat. n ln(n) R/S ln(R/S) V-Stat.
10 2.3026 4.1033 1.4118 1.2976 10 2.3026 4.1814 1.4306 1.3223
20 2.9957 6.5444 1.8786 1.4634 20 2.9957 6.6039 1.8877 1.4767
40 3.6889 13.1971 2.5800 2.0866 40 3.6889 12.7974 2.5492 2.0235
50 3.9120 13.5203 2.6042 1.9121 50 3.9120 13.3000 2.5878 1.8809
100 4.6052 21.2789 3.0577 2.1279 100 4.6052 20.8580 3.0377 2.0858
110 4.7005 27.5647 3.3165 2.6282 110 4.7005 27.8150 3.3256 2.6521
200 5.2983 40.1944 3.6937 2.8422 200 5.2983 40.2378 3.6948 2.8452
220 5.3936 37.1754 3.6156 2.5064 220 5.3936 36.6760 3.6021 2.4727
440 6.0868 41.7244 3.7311 1.9891 440 6.0868 40.8542 3.7100 1.9476
550 6.3099 50.0792 3.9136 2.1354 550 6.3099 48.2996 3.8774 2.0595

Table 3: Regression Results – Daily Sensex and Nifty Indices Returns

Statistical Value Sensex Nifty
Hurst Exponent 0.634 0.626
P-Value of the Regression Coefficient 0.000 0.000
Constant 0.109 0.136
R 2
0.959 0.956
Standard Error of Estimate 0.181 0.185

Tables 4 and 5 indicate that all the test statistics of logarithmic index returns series are
greater than the critical value of 1.96 significantly under different embedding dimension and
ratio of tolerance to standard deviation. Thus, the null hypothesis of IID is rejected for both
series. The results strongly suggest that both the series are nonlinearly dependent at the 5%
level of significance, a characteristic of chaotic behavior. We have shuffled the logarithmic
index returns series 10 times and subjected every shuffled series to the BDS test. The results
are significant at 5% level. It implies a strong evidence of nonlinear dependence on the
logarithmic index returns time series in both the indices.

Detrended Fluctuation Analysis

R/S analysis is generally considered as the less efficient method and is replaced by DFA in a
majority of recent applied papers (Grech and Mazur, 2004; Alvarez-Ramirez et al., 2008; and
Czarnecki et al., 2008). The reasons for such replacement are usually stated as bias for non-
stationary data and general overestimation of Hurst exponent b R/S. The results of DFA-1
are presented in Figure 1 for both Sensex and Nifty time series.

12 The IUP Journal of Applied Finance, Vol. 21, No. 4, 2015

 Table 4: BDS Test Results – Daily Nifty Index Returns
Dimension BDS Statistic Std. Error z-Statistic Normal Prob. Bootstrap Prob.
2 0.024002 0.001914 12.53728 0.0000 0.0000
3 0.046838 0.003043 15.39298 0.0000 0.0000
4 0.065247 0.003624 18.00359 0.0000 0.0000
5 0.078660 0.003778 20.81950 0.0000 0.0000
6 0.085648 0.003644 23.50057 0.0000 0.0000

Table 5: BDS Test Results – Daily Sensex Index Returns

Dimension BDS Statistic Std. Error z-Statistic Normal Prob. Bootstrap Prob.
2 0.024038 0.001948 12.34102 0.0000 0.0000
3 0.048856 0.003095 15.78459 0.0000 0.0000
4 0.069223 0.003686 18.78086 0.0000 0.0000
5 0.082670 0.003842 21.51790 0.0000 0.0000
6 0.089786 0.003705 24.23109 0.0000 0.0000

Figure 1: Detrended Fluctuation Analysis (DFA) of Sensex and Nifty

(a) Sensex (b) Nifty

1.0e+52
8.0e+55
n_close
n_close

0.0e+00 0.0e+00
0 1000 2000 3000 0 500 1000 1500 2000
Time Time

DFA, Detrending: x~1+t DFA, Detrending: x~1+t

RMSE RMSE
125

115.5
log(RMSE)

log(RMSE)

H=0.618 H=0.655
123

113.5

2 3 4 5 6 7 2 3 4 5 6 7
log(scale) log(scale)

The results of DFA-1 coincide with results of R/S test with Hurst coefficient greater than
0.5 in both the series. The Sensex reported H value of 0.618, whereas the Nifty reported H
value of 0.655 (Table 6). Both the series are persistent at the scale ratio of 2 to 12. Scale ratio
is the ratio of successive scales. Thus, the traditional R/S method is a strong measure of
persistence even when compared with the recent technique of DFA.

Test of Persistence in Indian Stock Market: A Rescaled Range Analysis 13

 Table 6: DFA Test Results
Hurst Exponent Sensex Nifty
DFA-1 0.618 0.655

Conclusion
In this study, we have examined the behavior of the Indian Stock Exchange indices returns
series using the R/S analysis, the BDS test and DFA. The Hurst exponents found in the rescaled
range analysis are greater than 0.5 in both series and reveal that both series are persistent,
fractal and self-similar. These results are confirmed using DFA for both the series. However, the
values of the Hurst exponents are relatively low (around 0.63), which indicates that both series
have strong noisy components. Nonlinearity was found in our time series using the BDS test.
The test statistics are very significant, which indicates a strong evidence of nonlinearity. The
findings of nonlinear serial correlation in both series are consistent with the other studies that
the BDS test has been applied to detect nonlinear structure in the financial data. These studies
include foreign exchange rate data (Hsieh, 1989), NYSE weekly stock return (Scheinkman and
LeBaron, 1989), and US daily return of futures contracts (Yang and Brorsen, 1993). Nonlinearity
is one of the indications of chaotic behavior. Thus, the results confirm that the indices exhibit
chaotic behavior as the returns series is characterized by non-randomness, nonlinear dependence
and deterministic.
The existence of fractal structure implies that the technical analysis tools like the Elliot
Wave Principles can be utilized when analyzing the price movements in any stock markets.
The chaotic behavior found in our time series indicates that the predictions of the price
movements in the Indian stock market are very difficult by the traditional econometric
methods, especially in the long term. The limitations of long-term prediction strongly suggest
that the techniques of charting (technical analysis) which try to infer the short-term future
behavior of the asset prices based on observed up and downturns in the past, may be applied
when analyzing the price movements in the Indian stock markets.

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Test of Persistence in Indian Stock Market: A Rescaled Range Analysis 17

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