# Scaling of the distribution of fluctuations of financial market indices

## I Introduction and Background

The analysis of financial data by methods developed for physical systems has a long tradition and has recently attracted the interest of physicists. Among the reasons for this interest is the scientific challenge of understanding the dynamics of a strongly fluctuating complex system with a large number of interacting elements. In addition, it is possible that the experience gained by studying complex physical systems might yield new results in economics.

Financial markets are complex dynamical systems with many interacting elements that can be grouped into two categories: (i) the traders — such as individual investors, mutual funds, brokerage firms, and banks — and (ii) the assets — such as bonds, stocks, futures, and options. Interactions between these elements lead to transactions mediated by the stock exchange. The details of each transaction are recorded for later analysis. The dynamics of a financial market are difficult to understand not only because of the complexity of its internal elements but also because of the many intractable external factors acting on it, which may even differ from market to market. Remarkably, the statistical properties of certain observables appear to be similar for quite different markets, consistent with the possibility that there may exist “universal” results.

The most challenging difficulty in the study of a financial market is that the nature of the interactions between the different elements comprising the system is unknown, as is the way in which external factors affect it. Therefore, as a starting point, one may resort to empirical studies to help uncover the regularities or “empirical laws” that may govern financial markets.

The interactions between the different elements comprising financial markets generate many observables such as the transaction price, the share volume traded, the trading frequency, and the values of market indices \[Fig. 1\]. A number of studies investigated the time series of returns on varying time scales $`\mathrm{\Delta }t`$ in order to probe the nature of the stochastic process underlying it . For a time series $`S(t)`$ of prices or market index values, the return $`G(t)G_{\mathrm{\Delta }t}(t)`$ over a time scale $`\mathrm{\Delta }t`$ is defined as the forward change in the logarithm of $`S(t)`$,

$$G_{\mathrm{\Delta }t}(t)\mathrm{ln}S(t+\mathrm{\Delta }t)\mathrm{ln}S(t).$$
(1)   
For small changes in $`S(t)`$, the return $`G_{\mathrm{\Delta }t}(t)`$ is approximately the forward relative change,

$$G_{\mathrm{\Delta }t}(t)\frac{S(t+\mathrm{\Delta }t)S(t)}{S(t)}.$$
(2)   
In 1900, Bachelier proposed the first model for the stochastic process of returns—an uncorrelated random walk with independent, identically Gaussian distributed (i.i.d) random variables. This model is natural if one considers the return over a time scale $`\mathrm{\Delta }t`$ to be the result of many independent “shocks”, which then lead by the central limit theorem to a Gaussian distribution of returns . However, empirical studies  show that the distribution of returns has pronounced tails in striking contrast to that of a Gaussian. To illustrate this fact, we show in Fig. 2 the 10 min returns of the S&P 500 market index for 1986-1987 and contrast it with a sequence of i.i.d. Gaussian random variables. Both are normalized to have unit variance. Clearly, large events are very frequent in the data, a fact largely underestimated by a Gaussian process. Despite this empirical fact, the Gaussian assumption for the distribution of returns is widely used in theoretical finance because of the simplifications it provides in analytical calculation; indeed, it is one of the assumptions used in the classic Black-Scholes option pricing formula.

In his pioneering analysis of cotton prices, Mandelbrot observed that in addition to being non-Gaussian, the process of returns shows another interesting property: “time scaling” — that is, the distributions of returns for various choices of $`\mathrm{\Delta }t`$, ranging from 1 day up to 1 month have similar functional forms. Motivated by (i) pronounced tails, and (ii) a stable functional form for different time scales, Mandelbrot proposed that the distribution of returns is consistent with a Lévy stable distribution — that is, the returns can be modeled as a Lévy stable process. Lévy stable distributions arise from the generalization of the central limit theorem to random variables which do not have a finite second moment \[see Appendix A\].

Conclusive results on the distribution of returns are difficult to obtain, and require a large amount of data to study the rare events that give rise to the tails. More recently, the availability of high frequency data on financial market indices, and the advent of improved computing capabilities, has facilitated the probing of the asymptotic behavior of the distribution. For these reasons, recent empirical studies of the S&P 500 index analyze typically $`10^6`$$`10^7`$ data points, in contrast to approximately 2000 data points analyzed in the classic work of Mandelbrot. Reference  reports that the central part of the distribution of S&P 500 returns appears to be well fit by a Lévy distribution, but the asymptotic behavior of the distribution of returns shows faster decay than predicted by a Lévy distribution. Hence, Ref.  proposed a truncated Lévy distribution—a Lévy distribution in the central part followed by an approximately exponential truncation—as a model for the distribution of returns. The exponential truncation ensures the existence of a finite second moment, and hence the truncated Lévy distribution is not a stable distribution . The truncated Lévy process with i.i.d. random variables has slow convergence to Gaussian behavior due to the Lévy distribution in the center, which could explain the observed time scaling for a considerable range of time scales.

In addition to the probability distribution, a complementary aspect for the characterization of any stochastic process is the quantification of correlations. Studies of the autocorrelation function of returns show exponential decay with characteristic decay times $`\tau _{ch}`$ of only 4 min. As is clear from Fig. 3(a), for time scales beyond 20 min the correlation function is at the level of noise, in agreement with the efficient market hypothesis which states that is not possible to predict future stock prices from their previous values. If price-correlations were not short-range, one could devise a way to make money from the market indefinitely.

It is important to note that lack of linear correlation does not imply an i.i.d. process for the returns, since there may exist higher-order correlations \[Fig 3(b)\]. Indeed, the amplitude of the returns, referred to in economics as the volatility, shows long-range time correlations that persist up to several months, and are characterized by an asymptotic power-law decay.

## II Motivation

A recent preliminary study reported that the distributions of 5 min returns for 1000 individual stocks and the S&P 500 index decay as a power-law with an exponent well outside the stable Lévy regime. Consistent results were found by studies both on stock markets  and on foreign exchange markets. These results raise two important questions:

First, the distribution of returns has a finite second moment, thus, we would expect it to converge to a Gaussian because of the central limit theorem. On the other hand, preliminary studies suggest the distributions of returns retain their power-law functional form for long time scales. So, we can ask which of these two scenarios is correct? We find that the distributions of returns retain their functional form for time scales up to approximately 4 days, after which we find results consistent with a slow convergence to Gaussian behavior.

Second, power-law distributions are not stable distributions, but the distribution of returns retains its functional form for a range of time scales. It is then natural to ask how can this scaling behavior possibly arise? One possible explanation is the recently-proposed exponentially-truncated Lévy distribution. However, the truncated Lévy process is constructed out of i.i.d. random variables and hence is not consistent with the empirically-observed long persistence in the autocorrelation function of the volatility of returns . Moreover, our data support the possibility that the asymptotic nature of the distribution is a power-law with an exponent outside the Lévy regime. Also, we will argue that the scaling behavior observed in the distribution of returns may be connected to the slow decay of the volatility correlations.

The organization of the paper is as follows. Section III describes the data analyzed. Sections IV and V study the distribution of returns of the S&P 500 index on time scales $`\mathrm{\Delta }t1`$ day and $`\mathrm{\Delta }t>1`$ day, respectively. Section VI discusses how time correlations in volatility are related to the time scaling of the distributions, and Sect. VII presents concluding remarks.

## III The Data analyzed

First, we analyze the S&P 500 index, which comprises 500 companies chosen for market size, liquidity, and industry group representation in the US. The S&P 500 is a market-value weighted index (stock price times number of shares outstanding), with each stock’s weight proportional to its market value. The S&P 500 index is one of the most widely used benchmarks of U.S. equity performance. In our study, we first analyze database (i) which contains “high-frequency” data that covers the 13 years period 1984–1996, with a recording frequency of less than 1 min. The total number of records in this database exceeds $`4.5\times 10^6`$. To investigate longer time scales, we study two other databases. Database (ii) contains daily records of the S&P 500 index for the 35-year period 1962–1996, and database (iii) contains monthly records for the 71-year period 1926–1996.

In order to test if our results are limited to the S&P 500 index, we perform a parallel analysis on two other market indices. Database (iv) contains 3560 daily records of the NIKKEI index of the Tokyo stock exchange for the 14-year period 1984–1997, and database (v) contains 4649 daily records of the Hang-Seng index of the Hong Kong stock exchange for the 18-year period 1980–1997.

## IV The distribution of returns for $`\mathrm{\Delta }t1`$ day

### A The distribution of returns for $`\mathrm{\Delta }t=1`$ min

First, we analyze the values of the S&P500 index from the high-frequency data for the 13-year period 1984–1996, which extends the database studied in Ref.  by an additional 7 years. The data are typically recorded at 15 second intervals. We first sample the data at 1 min intervals and generate a time series $`S(t)`$ with approximately 1.2 million data points. From the time series $`S(t)`$, we compute the return $`GG_{\mathrm{\Delta }t}(t)`$ which is the relative change in the index, defined in Eq. (1).

In order to compare the behavior of the distribution for different time scales $`\mathrm{\Delta }t`$, we define a normalized return $`gg_{\mathrm{\Delta }t}(t)`$

$$g\frac{GG_T}{v}.$$
(3)   
Here, the time averaged volatility $`vv(\mathrm{\Delta }t)`$ is defined through $`v^2G^2_TG_{T}^{}{}_{}{}^{2}`$ and $`\mathrm{}_T`$ denotes an average over the entire length of the time series. Figure 4(a) shows the cumulative distribution of returns for $`\mathrm{\Delta }t=1`$ min. For both positive and negative tails, we find a power-law asymptotic behavior

$$P(g>x)\frac{1}{x^\alpha },$$
(4)   
similar to what was found for individual stocks. For the region $`3g50`$, regression fits yield

$$\alpha =\{\begin{array}{cc}3.05\pm 0.04\hfill & \text{(positive tail)}\hfill \\ 2.94\pm 0.08\hfill & \text{(negative tail)}\hfill \end{array},$$
(5)   
well outside the Lévy stable range, $`0\alpha <2`$ . Consistent values for $`\alpha `$ are also obtained from the density function. For a more accurate estimation of the asymptotic behavior, we use the modified Hill estimator \[Fig. 5(a,b)\]. We obtain estimates for the asymptotic slope in the region $`3g50`$ :

$$\alpha =\{\begin{array}{cc}2.93\pm 0.11\hfill & \text{(positive tail)}\hfill \\ 3.02\pm 0.15\hfill & \text{(negative tail)}\hfill \end{array}.$$
(6)   
For the region $`g3`$, regression fits yield smaller estimates of $`\alpha `$, consistent with the possibility of a Lévy distribution in the central region. The values of $`\alpha `$ obtained in this range are quite sensitive to the bounds of the region used for fitting. Our estimates range from $`\alpha 1.35`$ up to $`\alpha 1.8`$ for different fitting regions in the interval $`0.1g6`$. For example, in the region $`0.5g3`$, we obtain

$$\alpha \{\begin{array}{cc}1.6\hfill & \text{(positive tail)}\hfill \\ 1.7\hfill & \text{(negative tail)}\hfill \end{array},$$
(7)   
which are consistent with the result $`\alpha 1.4`$ found for small values of $`g`$ in Ref. . Note that in Ref.  the estimates of $`\alpha `$ were calculated using the scaling form of the return probability to the origin $`P(0)`$. It is possible that for the financial data analyzed here, $`P(0)`$ is not the optimal statistic, because of the discreteness of the individual-company distributions that comprise it. It is also possible that our values of $`\alpha `$ for small values of $`g`$ could be due to the discreteness in the returns of the individual companies comprising the S&P 500.

### B Scaling of the distribution of returns for $`\mathrm{\Delta }t`$ up to 1 day

Next, we study the distribution of normalized returns for longer time scales. Figure 6(a) shows the cumulative distribution of normalized S&P 500 returns for time scales up to 512 min (approximately 1.5 days). The distribution appears to retain its power-law functional form for these time scales. We verify this scaling behavior by analyzing the moments of the distribution of normalized returns $`g`$,

$$\mu _k|g|^k_T,$$
(8)   
where $`\mathrm{}_T`$ denotes an average over all the normalized returns for all the bins. Since $`\alpha 3`$, we expect $`\mu _k`$ to diverge for $`k3`$, and hence we compute $`\mu _k`$ for $`k<3`$.

Figure 6(b) shows the moments of the normalized returns $`g`$ for different time scales from 5 min up to 1 day. The moments do not vary significantly for the above time scales, confirming the apparent scaling behavior of the distribution observed in Fig. 6(a).

## V The distribution of returns for $`\mathrm{\Delta }t1`$ day

### A The S&P 500 index

For time scales beyond 1 day, we use database (ii) which contains daily-sampled records of the S&P 500 index for the 35-year period 1962–1996. Figure 7(a) shows the agreement between distributions of normalized S&P 500 daily-returns from database (i), which contains 1 min sampled data, and database (ii), which contains daily-sampled data. Regression fits for the region $`1g10`$ give estimates of $`\alpha 3`$. Figure 7(b) shows the scaling behavior of the distribution for $`\mathrm{\Delta }t=`$ 1, 2, and 4 days. For these choices of $`\mathrm{\Delta }t`$, the scaling behavior is also visible for the moments \[Fig. 7(c)\].

Figure 8(a) shows the distribution of the S&P 500 returns for $`\mathrm{\Delta }t=4,8`$ and 16 days. The data are now consistent with a slow convergence to Gaussian behavior. This is also visible for the moments \[Fig. 8(b)\].

### B The NIKKEI and Hang-Seng indices

The S&P 500 is but one of the many stock market indices. Hence, we investigate if the above results regarding the power-law asymptotic behavior of the distribution of returns hold for other market indices as well. Figure 9 compares the distributions of daily returns for the NIKKEI index of the Tokyo stock exchange and the Hang-Seng index of the Hong Kong stock exchange with that of the S&P 500. The distributions have similar functional forms, suggesting the possibility of “universal” behavior of these distributions. In addition, the estimates of $`\alpha `$ from regression fits,

$$\alpha =\{\begin{array}{cc}3.05\pm 0.16\hfill & \text{(NIKKEI)}\hfill \\ 3.03\pm 0.16\hfill & \text{(Hang-Seng)}\hfill \end{array},$$
(9)   
are in good agreement for the three cases.

## VI Dependence of average volatility on time scale

The behavior of the time-averaged volatility $`v(\mathrm{\Delta }t)`$ as a function of the time scale $`\mathrm{\Delta }t`$ is shown in Fig. 3(c). We find a power-law dependence,

$$v(\mathrm{\Delta }t)(\mathrm{\Delta }t)^\delta .$$
(10)   
We estimate $`\delta 0.7`$ for time scales $`\mathrm{\Delta }t<20`$ min. This value is larger than $`1/2`$ due to the exponentially-damped time correlations, which are significant up to approximately 20 min. Beyond 20 min, $`\delta 0.5`$, indicating the absence of correlations in the returns, in agreement with Fig. 3(a). The time-averaged volatility is also consistent with essentially uncorrelated behavior for the daily and monthly returns.

## VII Volatility Correlations and Time Scaling

We have presented evidence that the distributions of returns retain the same functional form for a range of time scales\[see Fig. 10 and Table I\]. Here, we investigate possible causes of this scaling behavior. Previous explanations of scaling relied on Lévy stable and exponentially-truncated Lévy processes. However, the empirical data that we analyze are not consistent with either of these two processes.

### A Rate of convergence

Here, we compare the rate of convergence of the probability of the returns to that of a computer-generated time series which has the same distribution but is statistically independent by construction. This way, we will be able to study the convergence to Gaussian behavior of independent random variables distributed as a power-law, with an exponent $`\alpha 3`$.

First, we generate a time series $`XX_k,k=1,\mathrm{},40\times 10^6`$ distributed as $`P(X>x)1/x^3`$. We next calculate the new random variables $`I_n_{i=1}^nX_k`$, and compute the cumulative distributions of $`I_n`$ for increasing values of $`n`$. These distributions show faster convergence with increasing $`n`$ than the distributions of returns \[Fig. 11(a)\]. This convergence is also visible in the moments. Figures 11(a,b) show that for $`n=256`$, both the moments and the cumulative distribution show Gaussian behavior. In contrast, for the distribution of returns, we observe significantly slower convergence to Gaussian behavior: In the case of the S&P 500 index, one observes a possible onset of convergence for $`\mathrm{\Delta }t`$ 4 days (1560 mins), starting from 1 min returns.

These results confirm the existence of time dependencies in the returns. Next, we show that the scaling behavior observed for the S&P 500 index no longer holds when we destroy the dependencies between the returns at different times.

### B Randomizing the time series of returns

We start with the 1 min returns and then destroy all the time dependencies that might be present by shuffling the time series of $`G_{\mathrm{\Delta }t=1}(t)`$, thereby creating a new time series $`G_1^{sh}(t)`$ which contains statistically-independent returns. By adding up $`n`$ consecutive returns of the shuffled series $`G_1^{sh}(t)`$, we construct the $`n`$ min returns $`G_n^{sh}(t)`$.

Figure 12(a) shows the cumulative distribution of $`G_n^{sh}(t)`$ for increasing values of $`n`$. We find a progressive convergence to Gaussian behavior with increasing $`n`$. This convergence to Gaussian behavior is also clear in the moments of $`G_n^{sh}(t)`$, which rapidly approach the Gaussian values with increasing $`n`$ \[Fig. 12(b)\]. This rapid convergence confirms that the time dependencies cause the observed scaling behavior.

## VIII Discussion

We have presented a detailed analysis of the distribution of returns for market indices, for time intervals $`\mathrm{\Delta }t`$ ranging over roughly 4 orders of magnitude, from 1 min up to 1 month ($``$ 16,000 min). We find that the distribution of returns is consistent with a power-law asymptotic behavior, characterized by an exponent $`\alpha 3`$, well outside the stable Lévy regime $`0<\alpha <2`$. For time scales $`\mathrm{\Delta }t(\mathrm{\Delta }t)_\times `$, where $`(\mathrm{\Delta }t)_\times 4`$ days, our results are consistent with slow convergence to Gaussian behavior.

We have also demonstrated that the scaling behavior does not hold if we destroy all the time dependencies by shuffling. The breakdown of the scaling behavior of the distribution of returns upon shuffling the time series suggests that the long-range volatility correlations, which persist up to several months, may be one possible reason for the observed scaling behavior.

Recent studies  show that the distribution of volatility is consistent with an asymptotic power-law behavior with exponent 3, just as observed for the distribution of returns. This finding suggests that the process of returns may be written as

$$g(t)=ϵ(t)v(t),$$
(11)   
where $`g(t)`$ denotes the return at time $`t`$, $`v(t)`$ denotes the volatility, and $`ϵ(t)`$ is an i.i.d. random variable independent of $`v(t)`$. Since the asymptotic behavior of the distributions of $`v(t)`$ and $`g(t)`$ is consistent with power-law behavior, $`ϵ(t)`$ should have an asymptotic behavior with faster decay than either $`g(t)`$ or $`v(t)`$. In fact, Eq. (11) is central to all the ARCH models , with $`ϵ(t)`$ assumed to be Gaussian distributed.

Different ARCH processes assume different recursion relations for $`v(t)`$. In the standard ARCH model, $`v(t)=\alpha +\beta g^2(t1)`$, leading to a power law distribution of returns with exponent depending on the parameters $`\alpha `$ and $`\beta `$. However, the standard ARCH process predicts a volatility correlation that decays exponentially, since $`v(t)`$ depends only on the previous event, and cannot account for the observed long-range persistence in $`v(t)`$. To try to remedy this, one can require $`v(t)`$ to depend not only on the previous value of $`g(t)`$ but on a finite number of past events. This generalization is called the GARCH model. Dependence of $`v(t)`$ on the finite past leads not to a power-law decay (as is observed empirically), but to volatility correlations that decay exponentially —with larger decay times as the number of events “remembered” is increased.

In order to explain the long range persistence of the autocorrelation function of the volatility, one must assume that $`v(t)`$ depends on all the past rather than a finite number of past events . Such a description would be consistent with the empirical finding of long-range correlations in the volatility, and the observation that the distributions of $`g(t)`$ and $`v(t)`$ have similar asymptotic forms. If the process of returns were governed by the volatility, as in Eq. (11), then the volatility would seem to be the more fundamental process. In fact, it is possible that the volatility is a measure of the amount of information arriving into the market, and that the statistical properties of the returns may be “driven” by this information.

## IX Acknowledgments

We thank J.-P. Bouchaud, M. Barthélemy, S. V. Buldyrev, P. Cizeau, X. Gabaix, I. Grosse, S. Havlin, K. Illinski, P. Ch. Ivanov, C. King, C.-K. Peng, B. Rosenow, D. Sornette, D. Stauffer, S. Solomon, J. Voit and especially R. N. Mantegna for stimulating discussions and helpful suggestions. The authors also thank Bob Tompolski for his help throughout this work. MM thanks DFG and LANA thanks FCT/Portugal for financial support. The Center for Polymer Studies is supported by the NSF.

## A Lévy Stable Distributions

Lévy stable distributions arise from the generalization of the central limit theorem to a wider class of distributions. Consider the partial sum $`P_n_{i=1}^nx_i`$ of independent identically distributed (i.i.d.) random variables $`x_i`$. If the $`x_i`$’s have finite second moment, the central limit theorem holds and $`P_n`$ is distributed as a Gaussian in the limit $`n\mathrm{}`$.

If the random variables $`x_i`$ are characterized by a distribution having asymptotic power-law behavior

$$P(x)x^{(1+\alpha )},$$
(A1)   
where $`\alpha <2`$, then $`P_n`$ will converge to a Lévy stable stochastic process of index $`\alpha `$ in the limit $`n\mathrm{}`$.

Except for special cases, such as the Cauchy distribution, Lévy stable distributions cannot be expressed in closed form. They are often expressed in terms of their Fourier transforms or characteristic functions, which we denote $`\phi (q)`$, where $`q`$ denotes the Fourier transformed variable. The general form of a characteristic function of a Lévy stable distribution is

$$\mathrm{ln}\phi (q)=\{\begin{array}{cc}i\mu q\gamma |q|^\alpha \left[1+i\beta \frac{q}{|q|}tg\left(\frac{\pi }{2}\alpha \right)\right]\hfill & [\alpha 1]\hfill \\ i\mu q\gamma |q|\left[1+i\beta \frac{q}{|q|}\frac{2}{\pi }\mathrm{ln}|q|\right]\hfill & [\alpha =1]\hfill \end{array},$$
(A2)   
where $`0<\alpha 2`$, $`\gamma `$ is a positive number, $`\mu `$ is the mean, and $`\beta `$ is an asymmetry parameter. For symmetric Lévy distributions ($`\beta =0`$), one has the functional form

$$P(x)=\frac{1}{2\pi }_{\mathrm{}}^{\mathrm{}}exp(\gamma |q|^\alpha )e^{iqx}𝑑q.$$
(A3)   
For $`\alpha =1`$, one obtains the Cauchy distribution and for the limiting case $`\alpha =2`$, one obtains the Gaussian distribution.

By construction, Lévy distributions are stable, that is, the sum of two independent random variables $`x_1`$ and $`x_2`$, characterized by the same Lévy distribution of index $`\alpha `$, is itself characterized by a Lévy distribution of the same index. The functional form of the distribution is maintained, if we sum up independent, identically distributed Lévy stable random variables.

For Lévy distributions, the asymptotic behavior of $`P(x)`$ for $`x1`$ is a power-law,

$$P(x)x^{(1+\alpha )}.$$
(A4)   
Hence, the second moment diverges. Specifically, $`E\{|x|^n\}`$ diverges for $`n\alpha `$ when $`\alpha <2`$. In particular, all Lévy stable processes with $`\alpha <2`$ have infinite variance. Thus, non-Gaussian stable stochastic processes do not have a characteristic scale. Although well-defined mathematically, these distributions are difficult to use and raise fundamental problems when applied to real systems where the second moment is often related to the properties of the system. In finance, an infinite variance would make risk estimation and derivative pricing impossible.

## B The Hill estimator (“local slopes”)

A common problem when studying a distribution that decays as a power law is how to obtain an accurate estimate of the exponent characterizing the asymptotic behavior. Here, we review the methods of Hill. The basic idea is to calculate the inverse of the local logarithmic slope $`\zeta `$ of the cumulative distribution $`P(g>x)`$,

$$\zeta \left(\frac{d\mathrm{log}P}{d\mathrm{log}x}\right)^1.$$
(B1)   
We then estimate the inverse asymptotic slope $`1/\alpha `$ by extrapolating $`\zeta `$ as $`1/x0`$. We start with the normalized returns $`g`$ and proceed in the following steps:

Step I: We sort the normalized returns $`g`$ in descending order. The sorted returns are denoted $`g_k`$, $`k=1,\mathrm{},N`$, where $`g_k>g_{k+1}`$ and $`N`$ is the total number of events.

Step II: The cumulative distribution is then expressed in terms of the sorted returns as

$$P(g>g_k)=\frac{k}{N}.$$
(B2)   
Figure 13 is a schematic of the cumulative distribution thus obtained. The inverse local slopes $`\zeta (g)`$ can be written as

$$\zeta (g_k)=\frac{\mathrm{log}(g_{k+1}/g_k)}{\mathrm{log}(P(g_{k+1})/P(g_k))}.$$
(B3)   
Using Eq. (B2), the above expression can be well approximated for large $`k`$ as

$$\zeta (g_k)k(\mathrm{log}(g_{k+1})\mathrm{log}(g_k)),$$
(B4)   
yielding estimates of the local inverse slopes.

Step III: We obtain the inverse local slopes through Eq. (B4). We can then compute an average of the inverse slopes over $`m`$ points,

$$\zeta \frac{1}{m}\underset{k=1}{\overset{m}{}}\zeta (g_k),$$
(B5)   
where the choice of the averaging window length $`m`$ varies depending on the number of events $`N`$ available.

Step IV: We plot the locally averaged inverse slopes $`\zeta `$ obtained in Step III as a function of the inverse normalized returns $`1/g`$ \[see, e.g., Fig. 5\]. We can then define two methods of estimating $`\alpha `$. In the first method, we extrapolate $`\zeta `$ as a function of $`1/g`$ to $`0`$, similarly to the method of successive slopes; this procedure yields the inverse asymptotic slope $`1/\alpha `$. In the second method, we average over all events for $`1/g`$ smaller than a given threshold , with the average yielding the inverse slope $`1/\alpha `$.

To test the Hill estimator, we analyze two surrogate data sets with known asymptotic behavior: (a) an independent random variable with $`P(g>x)=(1+x)^3`$, and (b) an independent random variable with $`P(g>x)=\mathrm{exp}(x)`$. As shown in Figs. 13(b,c), the method yields the correct results $`\alpha =3`$ and $`\alpha =\mathrm{}`$, respectively.