Seiji Armstrong

Huy Luong
Alon Arad Kane Hill

Seiji

Introduction , History of Fractal

Huy:
Failure of the Gaussian hypothesis

Alon:
Fractal Market Analysis

Kane:
Evolution of Mandelbrots financial models

1x

8x

Sierpinski Triangle, D = ln3/ln2

Mandelbrot Set, D = 2

 Fractals are Everywhere:

Found in Nature and Art

Mathematical Formulation:
Leibniz in 17th century
Georg Cantor in late 19th century

Mandelbrot, Godfather of Fractals:

late 20th century
How long is the coastline of Britain Latin adjective Fractus, derivation of

frangere: to create irregular fragments.

 Locally random and Globally deterministic Underlying Stochastic Process Similar system to financial markets !

Louis Bachelier - 1900

Consider a time series of stock price x(t) and designate L (t,T)

its natural log relative:

L (t,T) = ln x(t, T) ln x(t)

where increment L(t,T) is:

random statistically independent identically distributed Gaussian with zero mean

Stationary Gaussian random walk

Dow Jones Index [Feb 97 - Nov 03]

14000 12000 10000

Stock Value

8000 14000 12000 10000 2000 0 0 200 Time [day] 400 600 800 Stock Values 8000 1400 1600 6000 4000

Brownian motion

1000 1200 6000 4000 2000 0

1800

0 200 Time [day]

400

600

800

1000

1200

1400

1600

1800

Dow Jones x(t+9) - x(t) Series

1500 1000 500 0 0 -500 -1000 -1500 -2000 1500 1000 500 0 0 -500 -1000 -1500 500 1000 1500 2000 500 1000 1500 2000

Brownian motion x(t +9) - x(t) Series

Dow Jones Index Price Distribution Frequency [Feb 97 - Nov 03]

450 411 400 350 300 Frequency 250 224 168 140 239 392

200
150 100 50 12 0 -5SD -4SD 32

0 -3SD -2SD -1SD +1SD +2SD +3SD +4SD

2 +5SD

Standard Deviation

Sample Variance of L(t,T) varies in time Tail of histogram fatter than Gaussian Large price fluctuation seen as outliers in Gaussian

 Analyzing fractal characteristics are highly desirable for

non-stationary, irregular signals.

Standard methods such as Fourier are inappropriate for

stock market data as it changes constantly.

Fractal based methods . Relative dispersional methods ,

Rescaled range analysis methods do not impose this

assumption

 In 1951, Hurst defined a method to study natural

phenomena such as the flow of the Nile River. Process was not random, but patterned. He defined a constant, K, which measures the bias of the fractional Brownian motion.
In 1968 Mandelbrot defined this pattern as fractal. He

renamed the constant K to H in honor of Hurst. The Hurst exponent gives a measure of the smoothness of a fractal object where H varies between 0 and 1.

 It is useful to distinguish between random and non-

random data points.

If H equals 0.5, then the data is determined to be

random.
If the H value is less than 0.5, it represents anti-

persistence.
If the H value varies between 0.5 and 1, this represents

persistence.

 Start with the whole observed data set that covers a total

duration and calculate its mean over the whole of the available data

 Sum the differences from the mean to get the

cumulative total at each time point, V(N,k), from the beginning of the period up to any time, the result is a time series which is normalized and has a mean of zero

 Calculate the range

Calculate the standard deviation

 Plot log-log plot that is fit Linear Regression Y on X

where Y=log R/S and X=log n where the exponent H is the slope of the regression line.

Hurst Exponent
2

y = 0.8489x - 2.1265

ln(R/S)

0 2.00

2.50

3.00

3.50

4.00

4.50

-1

-1

ln(t)

 Gaussian market is a poor model of financial systems.

A new model which will incorporate the key features of

the financial market is the fractal market model.

Paret power law and Levy stability Long tails, skewed distributions

Income categories: Skilled workers, unskilled workers, part time workers and unemployed

 Reality: Temporal dependence of

large and small price

variations, fat tails

Pr(U > u) ~ u , 1 < < 2 The Hurst exponent, H = Brownian Motion P(t) = BH[ (t)]; suitable subordinator

Infinite variance: Risk

is a stable monotone, non decreasing, random processes with independent increments

Independence and fat tails : Cotton (1900-1905), Wheat price

in Chicago, Railroad and some financial rates

Fractional Brownian Motion (FBM) Brownian Motion P(t) = BH[ (t)] The Hurst exponent, H

Scale invariance after suitable renormalization (self -affine

processes are renormalizable (provide fixed points) ) under appropriate linear changes applied to t and P axes

Global property of the processs moments Trading time is viewed as (t) - called the cumulative

distribution function of a self similar random measure

Hurst exponent is fractal variant Main differences with other models: 1. Long Memory in volatility 2. Compatibility with martingale property of returns 3. Scale consistency 4. Multi-scaling

 L1 = Brownian motion L2 = M1963 (mesofractal) L3 = M1965 (unifractal) L4 = Multifractal models L5 = IBM shares L6 = Dollar-Deutchmark exchange rate

L7/8 = Multifractal models

Neglecting the big steps

More clock time - multifractal

model generation.

 Mandelbrot (1960, 1961, 1962, 1963, 1965, 1967, 1972,

1974, 1997, 1999, 2000, 2001, 2003, 2005)

All papers of Mandelbrots were used and analysed from

1960 2005 and can be obtained from www.math.yale.edu/mandelbrot

Fractal Market Anlysis:

Applying Chaos theory to Investment and Economcs (Edgar E. Peters) John Wiley & Sons Inc. (1994)