# Scaling transformation and probability distributions for financial time series

## 1 Introduction

One of the pillars of modern physics is the covariance of theories under certain group actions. What is particular to a given application, such as initial and boundary conditions usually breaks the symmetries of the theory. The symmetry group of observed data is therefore usually much smaller than the covariance group of the theory. An example is hydrodynamics where the equations are invariant under space-time translation and scaling, but where the solutions are not, in general, invariant. For theories that are covariant under scaling (to be specific, we can think of Navier-Stokes or Korteweg-De Vries equation) the situation is clear: the scaling properties, such as the spectral decomposition of the solution at each time are given by the scaling properties of the initial condition, the boundary conditions and external forces. The study of scaling transformation properties in the domain of economics and finance is more complicated because the evolution equations (or even the theory) governing the dynamics are largely unknown. It is thus not possible, in this case, to separate these scaling properties into a general property of an underlying theory and into what is particular to the situation under study. The observed financial chronological data results at least to some extent, of the particularities of each market and not only from a general abstract dynamics. Therefore there is no a priori reason to expect the data to exhibit simple properties under scaling transformation. Keeping this simple observation in mind, we will base our analysis of the scaling transformation on methods adapted to physical systems with complex behavior:   
i) Multifractal analysis of fully turbulent systems introduced in  and within that approach further developed inversion techniques developed in  (see also ).   
ii) Non-linear group representation theory developed in  and applied to many non-linear evolution equations in mathematical physics (see  for recent contributions).   
We apply these methods to two sets of financial chronological series :

1) Foreign exchange rate DM/$`\$`$: The data set provided by Olsen and Associates contains worldwide 1,472,241 bid-ask quotes for US dollar-German mark exchanges rates from 1 October 1992 until 30 September 1993. Tick by tick data are irregularly spaced in recorded time. To obtain price values at a regular time, we use linear interpolation between the two recorded time that immediately precede and follow the regular time. We obtain in this way, for a regular time of $`15`$ seconds, $`1,059,648`$ data. Our study focuses on the average price which is the mean of the bid and ask price.

2) Stock index CAC 40: The data set provided by the “Société de Bourse Française” contains $`1,045,890`$ quotes of the CAC 40 index from 3 January 1993 until 31 December 1996. Tick by tick data are regularly recorded every $`30`$ seconds, during opening hours (everyday from 10 am until 5 pm except week ends and national holidays). Our data base consist of the daily registers to which a constant has been subtracted such that the value at 10am is equal to the value of the previous day at 5pm. The subtracted jump process (with jumps at fixed times) can be analyzed on its own. This separation allows for a finer analysis of the rest of the process.

Using these data sets, we obtained three new results. First, the scaling transformation of the moments of the observed probability distribution is a non-linear representation that is well approximated by a linear representation, for small scaling parameters. This linear representation turns out to be diagonal. Secondly, the function of the order of the moment, defined by the spectrum of the generator is (non trivially) concave. This shows, by definition , that the data are multifractal. Note that the concavity in the case of FX market (DM/$`\$`$) can partially be deduced from  and is confirmed, independently of our work, by . Our third new result is an explicit expression of the family of probability distributions of price increments corresponding to different time increments.

For larger values of the scaling parameter, the linear approximation breaks down and the non linear terms of the representation has to be considered. The analysis of this letter can also be applied to the SP 500 index, where the results should be compared to the (unifractal) scaling behavior found in . It should also be compared with the, from the point of view of finance, more fundamental approach of stochastic time transformation (subordinate processes) that were applied to SP500  . These points are left for future investigations.

## 2 The mathematical framework

We suppose that the financial variable is described by a stochastic process $`(u(t))_{t0}`$ such that the set of increments $`u(t+\tau )u(t)`$, $`\tau 0`$ has a well defined transformation property under scaling of the time increment $`\tau `$, $`\tau a\tau `$, $`a>0`$. To avoid complications, irrelevant for the quite crude application reported in this letter, we suppose that $`(u(t))_{t0}`$ is stationary. Moreover, we will only consider the absolute value $`|u(t+\tau )u(t)|`$ of increments. Let $`w(\tau )=|u(\tau )u(0)|`$, $`\tau 0`$. This means that for each (scaling) $`a>0`$, there is a map $`T_a`$ of the set $`𝒲=\{w(\tau )|\tau 0\}`$ such that $`T_a(w(\tau ))=w(a\tau )`$. A group action $`T`$ of the scaling (dilatation) group ID (the set of strictly positive real numbers) on the set $`𝒲`$ is then defined, i.e $`T_{ab}(x)=T_a(T_b(x))`$ and $`T_e(x)=x`$ for $`a,b\text{ID},x𝒲`$, where $`e=1`$ is the identity element in ID. In the cases under consideration in this letter, it follows from the observed time series that the estimated probability distribution $`p_{w(\tau )}`$ in IR of $`w(\tau )`$ is different for different $`\tau >0`$. This is enough to ensure the existence of the action $`T`$, and moreover shows that $`T`$ gives a group action $`\overline{T}`$, on the set $`=\{p_{w(\tau )}|\tau 0\}`$ of probability distributions, defined by $`\overline{T}_a(p_{w(\tau )})=p_{w(a\tau )}`$.

The group action $`\overline{T}`$ is not linear, in spite of its appearance. To explicit properties of the scaling action $`\overline{T}`$, we change the coordinates of the elements in $``$. As in the case of fully developed turbulence, we use the moments as coordinates. For $`q`$, let the moment vector be the sequence $`S(q)=(S_r(q))_{r0}`$, where $`S_r(q)=_0^{\mathrm{}}x^rq(x)𝑑x`$ and $`r\text{IR}^+`$. Here we suppose that the set $``$ of probability measures is such that $`S_r(q)`$ exists for all orders $`r`$ and moreover that $`q`$ is determined by its moments of order $`r\text{IR}^+`$ (which is the case if for example the Fourier Transform of elements in $``$ are quasi analytic). Let $`𝒮`$ be the image (in the space $`C(\text{IR}^+)`$ of continuous real functions on $`\text{IR}^+`$) of $``$ under the coordinate transformation $`S`$. The image $`U`$ of the group action $`\overline{T}`$ is given by $`U_a=S\overline{T}_aS^1`$, i.e $`U_a(S(p_{w(\tau )}))=S(p_{w(a\tau )})`$. In the case $`U`$ is a linear diagonal representation, it has the form $`U_a=U_a^{(1)}`$, where for given real numbers $`\zeta _r`$ with $`r\text{IR}^+`$:

$`U_a^{(1)}(m)=(a^{\zeta _r}m_r)_{r0}`$ (1)   
for $`a\text{ID}`$ and $`mC(\text{IR}^+)`$, $`m_r`$ corresponding to a moment of order $`r`$. We note that $`\{\zeta _r|r\text{IR}^+\}`$ is the spectrum of the generator of the representation $`U^{(1)}`$. When $`U`$ is a non linear perturbation of $`U^{(1)}`$, there are algorithms permitting its construction. However they are outside the scope of this letter  . For commodity we denote $`s_r(\tau )=S_r(p_{w(\tau )})`$ which is the r-th component of $`U_\tau (S(p_{w(1)}))`$. An accurate and explicit approximation of the inverse transformation $`S^1`$, of the moment vectors $`s_r(\tau )`$ to probability distribution $`p_{w(\tau )}`$ has been developed in   . This permits to obtain directly from experimental data, an explicit formula for the family $`=\{p_{w(\tau )}\}_{\tau >0}`$ of probabilities. In fact, for each $`\tau \text{IR}^+`$ we can determine an element $`p_{w(\tau )}`$ by the formulas:

$`xp_{w(\tau )}(x)`$ $`=`$ $`\overline{p}(\mathrm{ln}x)`$   
$`\alpha (r,\tau )`$ $`=`$ $`{\displaystyle \frac{d\mathrm{ln}s_r(\tau )}{dr}}`$ (2)   
$`\mathrm{ln}\overline{p}(\alpha (r,\tau ))`$ $`=`$ $`\mathrm{ln}s_r(\tau )r{\displaystyle \frac{d\mathrm{ln}s_r(\tau )}{dr}}{\displaystyle \frac{1}{2}}\mathrm{ln}(2\pi ){\displaystyle \frac{1}{2}}{\displaystyle \frac{d^2\mathrm{ln}s_r(\tau )}{dr^2}}.`$ (3)   
where $`r\text{IR}^+`$.

## 3 Results

When the representation $`U`$ is linear it follows from expression (1) that $`\mathrm{ln}s_r(\tau )=A_r+\zeta _r\mathrm{ln}\tau `$, where $`A_r`$ and $`\zeta _r`$ are independent of $`\tau `$. Figure (1A) shows that, in the case of FX DM/$`\$`$, this is satisfied, to a good approximation with time increments $`\tau `$ and moments of order $`r`$ in the interval $`11\tau 2896`$ minutes and $`1r10`$. In contrast, for CAC40 the domain of validity of

the linear approximation also contains the small values of $`\tau `$: $`1\tau 2048`$ minutes and $`1r10`$ (see figure (2A)). Outside this domain in the ($`r,\tau `$) plane, the linear representation approximation breaks down. Inside the domain of validity of the linear representation approximation, the spectrum of the generator is presented in figure (1B) (resp. (2B)) in the case of FX DM/$`\$`$ (resp. CAC40). The function $`r\zeta _r`$ is in both cases (non trivially) concave, which by definition (see ) shows that the system has a multifractal behavior.

Finally, we present in figure (3A) and figure (3B) (resp. figure (4A) and figure (4B)) probability densities (M.A.M) given by (2) and (3), for $`\tau =8`$ minutes and $`\tau =512`$ minutes in the case of FX DM/$`\$`$ index (resp. CAC40). In all the cases, the experimental probability distribution is well approximated, for a large range of price increments, by the corresponding probability distributions in the family $`\{p_{w(\tau )}\}_{\tau >0}`$ constructed by the inverse method developed in  and . Other commonly used probability distributions are also presented in the figures for illustration.