# Scaling of the distribution of price fluctuations of individual companies

## I Introduction

The study of financial markets poses many challenging questions. For example, how can one understand a strongly fluctuating system that is constantly driven by external information? And, how can one account for the role of the feedback between the markets and the outside world, or of the complex interactions between traders and assets? An advantage for the researcher trying to answer these questions is the availability of huge amounts of data for analysis. Indeed, the activities at financial markets result in several observables, such as the values of different market indices, the prices of the different stocks, trading volumes, etc.

Some of the most widely studied market observables are the values of market indices. Previous empirical studies  show that the distribution of fluctuations —measured by the returns— of market indices has slow decaying tails and that the distributions apparently retain the same functional form for a range of time scales . Fluctuations in market indices reflect average behavior of the price fluctuations of the companies comprising them. For example, the S&P 500 is defined as the sum of the market capitalizations (stock price multiplied by the number of outstanding shares) of 500 companies representative of the US economy.

Here, we focus on a more “microscopic” quantity: individual companies. We analyze the tic-by-tic data  for the 1000 publicly-traded US companies with the largest market capitalizations and systematically study the statistical properties of their stock price fluctuations. A preliminary study  reported that the distribution of the 5 min returns for 1000 individual companies and the S&P 500 index decays as a power-law with an exponent $`\alpha 3`$ —well outside the stable Lévy regime ($`\alpha <2`$). Earlier independent studies on individual stock returns on longer time scales yield similar results . These findings raise the following questions:

First, how does the nature of the distribution of individual stock returns change with increasing time scale $`\mathrm{\Delta }t`$? In other words, does the distribution retain its power-law functional form for longer time scales, or does it converge to a Gaussian, as found for market indices ? If the distribution indeed converges to Gaussian behavior, how fast does this convergence occur? For the S&P 500 index, for example, one finds the distribution of returns to be consistent with a non-stable power-law functional form ($`\alpha 3`$) until approximately 4 days, after which an onset of convergence to Gaussian behavior is found .

Second, why is it that the distribution of returns for individual companies and for the S&P 500 index have the same asymptotic form? This finding is unexpected, since the returns of the S&P 500 are the weighted sums of the returns of 500 companies. Hence, we would expect the S&P 500 returns to be distributed approximately as a Gaussian, unless there were significant dependencies between the returns of different companies which prevent the central limit theorem from applying.

To answer the first question, we extend previous work on the distribution of returns for 5 min returns by performing empirical analysis of individual company returns for time scales up to 46 months. Our analysis uses two distinct data-bases detailed below. We find that the cumulative distribution of individual-company returns is consistent with a power-law asymptotic behavior with exponent $`\alpha 3`$, which is outside the stable Lévy regime. We also find that these distributions appear to retain the same functional form for time scales up to approximately 16 days. For longer time scales, we observe results consistent with a slow convergence to Gaussian behavior.

To answer the second question, we randomize each of the 500 time series of returns for the constituent 500 stocks of the S&P 500 index. A surrogate “index return” thus constructed from the randomized time series, shows fast convergence to Gaussian. Further, we find that the functional form of the distribution of returns remains unchanged for different system sizes (measured by the market capitalization) while the standard deviation decays as a power-law of market capitalization.

The organization of this paper is as follows. Section II describes the databases studied and the data analyzed. Sections III, IV, and V present results for the distribution of returns for individual companies for a wide range of time scales. Section VI discusses the role of cross-correlations between companies and possible reasons why market indices have statistical properties very similar to those of individual companies. Section VII contains some concluding remarks.

## II The Data analyzed

We analyze two different databases covering securities from the three major US stock markets, namely (i) the New York Stock Exchange (NYSE), (ii) the American Stock Exchange (AMEX), and (iii) the National Association of Securities Dealers Automated Quotation (Nasdaq) stock market. NYSE is the oldest stock exchange, tracing its origin to the Buttonwood Agreement of 1792. The NYSE is an agency auction market, that is, trading at the NYSE takes place by open bids and offers by Exchange members, acting as agents for institutions or individual investors. Buy and sell orders are brought to the trading floor, and prices are determined by the interplay of supply and demand. As of the end of November 1998, the NYSE lists over 3,100 companies. These companies have over $`2\times 10^{11}`$ shares, worth approximately USD $`10^{13}`$, available for trading on the Exchange.

In contrast to NYSE, Nasdaq uses computers and telecommunications networks which create an electronic trading system wherein the market participants meet over the computer rather than face to face. Nasdaq’s share volume reached $`1.6\times 10^{11}`$ shares in 1997 and dollar volume reached USD $`4.4\times 10^{12}`$. As of December 1998, the Nasdaq Stock Market listed over 5,400 US and non-US companies. Nasdaq and AMEX, have merged on October 1998, after the end of the period studied in this work.

The first database we consider is the trades and quotes (TAQ) database, for which we analyze the 2-year period January 1994 to December 1995. The TAQ database, which is published by NYSE since 1993, covers all trades at the three major US stock markets. This huge database is available in the form of CD-ROMs. The rate of publication was 1 CD-ROM per month for the period studied, but recently has increased to 2–3 CD-ROMs per month. The total number of transactions for the largest 1000 stocks is of the order of $`10^9`$ in the 2-year period studied.

The second database we analyze is the Center for Research and Security Prices (CRSP) database. The CRSP Stock Files cover common stocks listed on NYSE beginning in 1925, the AMEX beginning in 1962, and the Nasdaq Stock Market beginning in 1972. The files provide complete historical descriptive information and market data including comprehensive distribution information, high, low and closing prices, trading volumes, shares outstanding, and total returns.

The CRSP Stock Files provide monthly data for NYSE beginning December 1925 and daily data beginning July 1962. For the AMEX, both monthly and daily data begin in July 1962. For the Nasdaq Stock Market, both monthly and daily data begin in July 1972.

We also analyze the S&P 500 index, which comprises 500 companies chosen for market size, liquidity, and industry group representation in the US. In our study, we analyze data with a recording frequency of less than 1 min that cover the 13 years from January 1984 to December 1996. The total number of data points in this 13-year period exceeds $`4.5\times 10^6`$.

## III The distribution of returns for $`\mathrm{\Delta }t<1`$ day

The basic quantity studied for individual companies — $`i=1,2,\mathrm{},1000`$ — is the market capitalization $`S_i(t)`$, defined as the share price multiplied by the number of outstanding shares. The time $`t`$ runs over the working hours of the stock exchange—removing nights, weekends and holidays. For each company, we analyze the return

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

$$G_i(t,\mathrm{\Delta }t)\frac{S_i(t+\mathrm{\Delta }t)S_i(t)}{S_i(t)}.$$
(2)   
For time scales shorter than 1 day, we analyze the data from the TAQ database. We consider the largest 1000 companies, in decreasing order of values of their market capitalization on the first trading day, 3 January 1994. We sample the price of these 1000 companies at 5 min intervals. In order to obtain time series for market capitalization, we multiply the stock price of each company by the number of outstanding shares for that company at each sampling time. We thereby generate a time series, sampled at 5 min intervals, for the market capitalizations of each of the largest 1000 companies. Each of the 1000 time series has approximately 40,000 data points—corresponding to the number of 5 min intervals in the 2-year period—or about 40 million data points in total. For each time series of market capitalizations, we compute the 5 min returns using Eq. (1). We filter the data to remove spurious events, such as occur due to the inevitable recording errors.

### A The distribution of returns for $`\mathrm{\Delta }t=5`$ min

Figure 1(a) shows the cumulative distributions of returns $`G_i`$ for $`\mathrm{\Delta }t=5`$ min — the probability of a return larger than or equal to a threshold — for 10 individual companies randomly selected from the 1000 companies that we analyze. For each company $`i`$, the asymptotic behavior of the functional form of the cumulative distribution is “visually” consistent with a power-law,

$$P(G_i>x)\frac{1}{x^{\alpha _i}},$$
(3)   
where $`\alpha _i`$ is the exponent characterizing the power-law decay. In Fig. 1(b) we show the histogram for $`\alpha _i`$, obtained from power-law regression-fits to the positive tails of the individual cumulative distributions of all 1000 companies studied. The histogram has most probable value $`\alpha _{MP}=3`$.

Next, we compute the time-averaged volatility $`v_iv_i(\mathrm{\Delta }t)`$ of company $`i`$ as the standard deviation of the returns over the 2-year period

$$v_{i}^{}{}_{}{}^{2}G_{i}^{}{}_{}{}^{2}_TG_i_{T}^{}{}_{}{}^{2},$$
(4)   
where $`\mathrm{}_T`$ denotes a time average over the 40,000 data points of each time series, for the 2-year period studied. Figure 1(a) suggests that the widths of the individual distributions differ for different companies; indeed, companies with small values of market capitalization are likely to fluctuate more. In order to compare the returns of different companies with different volatilities, we define the normalized return $`g_ig_i(t,\mathrm{\Delta }t)`$ as

$$g_i\frac{G_iG_i_T}{v_i}.$$
(5)   
Figure 1(c) shows the ten cumulative distributions of the normalized returns $`g_i`$ for the same ten companies as in Fig 1(a). The distributions for all 1000 normalized returns $`g_i`$ have similar functional forms to these ten. Hence, to obtain better statistics, we compute a single distribution of all the normalized returns. The cumulative distribution $`P(g>x)`$ shows a power-law decay \[Fig 2(a)\],

$$P(g>x)\frac{1}{x^\alpha }.$$
(6)   
Regression fits in the region $`2g80`$ yield

$$\alpha =\{\begin{array}{cc}3.10\pm 0.03\hfill & \text{(positive tail)}\hfill \\ 2.84\pm 0.12\hfill & \text{(negative tail)}\hfill \end{array}.$$
(7)   
These estimates  of the exponent $`\alpha `$ are well outside the stable Lévy range, which requires $`0<\alpha <2`$.

In order to obtain an alternative estimate for $`\alpha `$, we use the methods of Hill . We first calculate the inverse of the local logarithmic slope of $`P(g)`$, $`\zeta ^1(g)d\mathrm{log}P(g)/d\mathrm{log}g`$, where $`g`$ is rank-ordered. We then estimate the asymptotic slope $`\alpha `$ by extrapolating $`\zeta `$ as a function of $`1/g0`$. Figure 3 shows the results for the negative and positive tails, for the 5 min returns for individual companies, each using all returns larger than 5 standard deviations. Extrapolation of the linear regression lines yield:

$$\alpha =\{\begin{array}{cc}2.84\pm 0.12\hfill & \text{(positive tail)}\hfill \\ 2.73\pm 0.13\hfill & \text{(negative tail)}\hfill \end{array}.$$
(8)   
### B Scaling of the distribution of returns for $`\mathrm{\Delta }t1`$day

The next logical step would be to extend the previous procedure to time scales longer than 5 min. However, this approach leads to unreliable results, the reason being that the estimate of the time averaged volatility—used to define the normalized returns of Eq. (5)—has estimation errors that increase with $`\mathrm{\Delta }t`$. For the distribution of 5 min returns, the previous procedure relies on 40,000 data points per company for the estimation of the time averaged volatility. For 500 min returns the number of data points available is reduced to 400 per company which leads to a much larger error in the estimate of $`v_i(\mathrm{\Delta }t)`$.

To circumvent the difficulty arising from the large uncertainty in $`v_i(\mathrm{\Delta }t)`$, we use an alternative procedure for estimating the volatility which relies on two observations. The first is that volatility decreases with market capitalization \[Fig. 4\]. The second is that companies with similar market capitalization typically have similar volatilities. Based on these observations, we make the hypothesis that the market capitalization is the most influential factor in determining the volatility,

$$v_i=v_i(S,\mathrm{\Delta }t).$$
(9)   
Hence, we group the returns of all the companies into “bins” according to the market capitalization of each company at the beginning of the interval for which the return is computed. We then compute the conditional probability of the $`\mathrm{\Delta }t`$ returns for each of the bins of market capitalization. We define $`G_SG_S(t,\mathrm{\Delta }t)`$ as the $`\mathrm{\Delta }t`$ returns of the subset of all companies with market capitalization $`S`$, and we then calculate the cumulative conditional probability $`P(G_Sx|S)`$. Figure 5(a) shows $`P(G_Sx|S)`$ for 30 min returns for four different bins of $`S`$. The functional form for each of each of the four distributions is consistent with a power-law.

We define a normalized return

$$g_Sg_S(t,\mathrm{\Delta }t)\frac{G_S(\mathrm{\Delta }t)G_S(\mathrm{\Delta }t)_S}{v_S(\mathrm{\Delta }t)},$$
(10)   
where $`\mathrm{}_S`$ denotes an average over all returns of all companies with market capitalization $`S`$. The average volatility $`v_Sv_S(\mathrm{\Delta }t)`$ is defined through the relation,

$$v_{S}^{}{}_{}{}^{2}G_{S}^{}{}_{}{}^{2}_SG_S_{S}^{}{}_{}{}^{2}.$$
(11)   
We show in Fig. 5(b) the cumulative conditional probability of the normalized 30 min returns $`P(g_Sx|S)`$ for the same four bins shown in Fig. 5(a). Visually, it seems clear that these distributions have power-law functional forms with similar values of $`\alpha `$. Hence, to obtain better statistics, we consider the normalized returns for all values of $`S`$ and compute a single cumulative distribution.

Figure 6(a) shows the distribution of normalized 30 min returns. We test if our alternative procedure of normalizing the returns by the time averaged volatility for each bin of market capitalization $`S`$ is consistent with the previous procedure of normalizing by the time averaged volatility for each company through Eq. (5). To this end, we also show in Fig. 6(a) the distribution of normalized 30 min returns using the normalization of Eq. (5). The distribution of returns obtained by both procedures are consistent with a power law decay of the same form as Eq. (6). Power-law regression fits to the positive tail yield estimates of $`\alpha =3.21\pm 0.08`$ for the former method and $`\alpha =3.23\pm 0.05`$ for the latter, confirming the consistency of the two procedures. The values of the exponent for 30 min time scales, $`\alpha =3.21\pm 0.08`$ (positive tail) and $`\alpha =3.01\pm 0.12`$ (negative tail), are also consistent with the estimates, Eq. (7), for 5 min normalized returns.

Next, we compute the distribution of returns for longer time scales $`\mathrm{\Delta }t`$. Figure 6(b) shows the cumulative distribution of the normalized returns for time scales from 5 min up to 1 day. We observe good “data collapse” with consistent values of $`\alpha `$ which suggests that the distribution of returns appears to retain its functional form for larger $`\mathrm{\Delta }t`$. The scaling of the distribution of returns for individual companies is consistent with previous results for the distribution of the S&P 500 index returns . The estimates of the exponent $`\alpha `$ from power-law regression fits to the cumulative distribution and from the Hill estimator are listed in Table I.

### C Scaling of the moments for $`\mathrm{\Delta }t<1`$ day

In the preceding subsection we reported that the distribution of returns retains the same functional form for 5 min$`<\mathrm{\Delta }t<`$ 1 day. We can further test this scaling behavior by analyzing the moments of the distribution of normalized returns $`g`$,

$$\mu _k|g|^k,$$
(12)   
where $`\mathrm{}`$ 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(c) 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, thus confirming the scaling behavior of the distribution observed in Fig 6(b).

## IV The distribution of returns for 1 day $`\mathrm{\Delta }t16`$ days

For time scales of 1 day or longer, we analyze data from the CRSP database. We analyze approximately $`3.5\times 10^7`$ daily records for about 16,000 companies for the 35-year period 1962-96. We expect the market capitalization of a company to change dramatically in such a long period of time. Further, we expect small companies to be more volatile than large companies. Hence, large changes that might occur in the market capitalization of a company will lead to large changes on its average volatility. To control for these changes in market capitalization, we adopt the method that was used in the previous subsection for $`\mathrm{\Delta }t>`$ 5 min.

Thus, we compute the cumulative conditional probability $`P(G_Sx|S)`$ that the return $`G_SG_S(t,\mathrm{\Delta }t)`$ is greater than $`x`$, for a given bin of average market capitalization $`S`$. We first divide the entire range of $`S`$ into bins of uniform length in logarithmic scale. We then compute a separate probability distribution for the returns $`G_S`$ which belong to a bin of average market capitalization $`S`$.

Figure 7(a) shows the cumulative distribution of daily returns $`P(G_S>x|S)`$ for different values of $`S`$. Since the widths of these distributions are different for different $`S`$, we analyze the normalized returns $`g_S`$, which were defined in Eq. (10).

Figure 7(b) shows the cumulative distribution $`P(g_S>x)`$ of the normalized daily returns $`g_S`$. These distributions appear to have similar functional forms for different values of $`S`$. In order to improve statistics, we compute a single cumulative distribution $`P(g_S>x)`$ of the normalized returns for all $`S`$. We observe a power-law behavior of the same form as Eq. (6). Regression fits yield estimates for the exponent, $`\alpha =2.96\pm 0.09`$ for the positive tail and $`\alpha =2.70\pm 0.10`$ for the negative tail.

Figure 8(a) compares the cumulative distributions of the normalized 1 day returns obtained from the CRSP and TAQ databases. The estimates of the power-law exponents obtained from regression fits are in good agreement for these two databases.

Figures 8(b,c) show the distributions of normalized returns for $`\mathrm{\Delta }t=1,4,16`$ days. The estimates of the exponent $`\alpha `$ increase slightly in value for the positive tail, while for the negative tail the estimates of $`\alpha `$ are approximately constant. The increase in $`\alpha `$ for the positive tail is also reflected in the moments \[Fig. 8(d)\].

## V The distribution of returns for $`\mathrm{\Delta }t16`$ days

The scaling behavior of the distributions of returns appears to break down for $`\mathrm{\Delta }t16`$ days, and we observe indications of slow convergence to Gaussian behavior. In Figs. 9(a,b) we show the cumulative distributions of the normalized returns for $`\mathrm{\Delta }t16`$ days. For the positive tail, we find indications of convergence to a Gaussian, while the negative tail appears not to converge. The convergence to Gaussian behavior is also apparent from the behavior of the moments for these time scales \[Fig. 9(c)\].

To summarize our results for the distribution of individual company returns, we find that (i) the distribution of normalized returns for individual companies is consistent with a power-law behavior characterized by an exponent $`\alpha 3`$, (ii) the distributions of returns retain the same functional form for a wide range of time scales $`\mathrm{\Delta }t`$, varying over 3 orders of magnitude, 5 min$`\mathrm{\Delta }t6240`$ min = 16 days, and (iii) for $`\mathrm{\Delta }t>16`$ days, the distribution of returns appears to slowly converge to a Gaussian \[Fig. 10\].

## VI Cross-Correlations

In this section we address the second question that we posed initially. That is, why is it that the distribution of returns for individual companies and for the S&P 500 index have the same asymptotic form? In the previous sections, we presented evidence that the distribution of returns scales for a wide range of time intervals. In a previous study , we demonstrated that this scaling behavior is possibly due to time dependencies, in particular, volatility correlations. Next, we will show that as the time correlations lead to the time scaling of the distributions of returns, so do cross correlations among different companies lead to a functional form of the distribution of returns of indices similar to that for single companies.

A direct way of analyzing the cross-correlations is by computing the cross-correlation matrix . Here, we take a different approach, by analyzing the distribution of returns as a function of market capitalization.

First, we compare the distributions of the S&P 500 index and that of individual companies. Figures 11(a,b) show the cumulative distribution $`P(gx)`$ for individual companies and for the S&P 500 index. The distributions show the same power-law behavior for $`2g80`$. This is surprising, because the distribution of index returns $`G_{SP500}(t,\mathrm{\Delta }t)`$ does not show convergence to Gaussian behavior—even though the 500 distributions of individual returns $`G_i(t,\mathrm{\Delta }t)`$ are not stable. Consider the family of index returns defined as the partial sum 

$$G_{(N)}(t,\mathrm{\Delta }t)\underset{i=1}{\overset{N}{}}w_iG_i(t,\mathrm{\Delta }t),$$
(13)   
where the weights $`w_iS_i/_{j=1}^NS_j`$ have weak time dependencies. From the central limit theorem for random variables with finite variance, we expect that the probability distribution of $`G_{(N)}`$ would change systematically with $`N`$ and approach a Gaussian for large $`N`$, provided there are no significant dependencies among the returns $`G_i`$ for different $`i`$. Instead, we find that the distribution of $`G_{(N)}`$ has the same asymptotic behavior as that for individual companies.

In order to show that the scaling behavior may be due to cross-correlations between companies, we first destroy any existing dependencies among the returns of different companies by randomizing each of the 1000 time series $`G_i(t)`$. By adding up the shuffled series, we construct a shuffled index return $`G_{(N)}^{sh}(t)`$ out of statistically independent companies with the same distribution of returns. Fig. 11(c) shows the cumulative distribution of the shuffled index returns $`G_{(N)}^{sh}(t,\mathrm{\Delta }t)`$ for increasing $`N`$ and $`\mathrm{\Delta }t=5`$ min. The distribution changes with $`N`$, and approaches a Gaussian shape for large $`N`$, which indicates that the scaling in Fig. 11(a) is caused by non-trivial dependencies between different companies.

## VII Discussion

We have presented a systematic analysis, on two different databases, of the distribution of returns for individual companies for time scales $`\mathrm{\Delta }t`$ ranging from 5 min up to $`4`$ years. 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 up to approximately 16 days. For longer time scales, the scaling behavior appears to break down and we observe “slow” convergence to Gaussian behavior.

We also find that the distribution of returns of individual companies and the S&P 500 index have the same asymptotic behavior. This scaling behavior does not hold when the cross-correlations between companies are destroyed, suggesting the existence of correlations between companies —as occurs in strongly interacting physical systems where power-law correlations at the critical point result in scale-invariant properties. Recent studies of the cross-correlation matrix using methods of random matrix theory  also show the existence of correlations that are present through a wide range of time scales from 30 mins  up to 1 day . These studies  show that the largest eigenvalue of the cross-correlation matrix corresponds to correlations that pervade the entire market, and a few other large eigenvalues correspond to clusters of companies that are correlated amongst each other.

## VIII Acknowledgments

We thank J.-P. Bouchaud, M. Barthélemy, S. V. Buldyrev, P. Cizeau, X. Gabaix, I. Grosse, S. Havlin, K. Illinski, 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. We thank X. Gabaix, C. King, J. Stein, and especially T. Lim for help with obtaining the data. We are also very grateful to L. Giannitrapani of the SCV at Boston University for her generous help in allocating the necessary computer resources, and to R. 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 NSF.

## A Dependence of volatility on size

We find that the average volatility for each bin, $`v_S(\mathrm{\Delta }t)`$ shows an interesting dependence on the market capitalization. In Fig. 4, we plot the standard deviation as a function of size on a log-log scale for $`\mathrm{\Delta }t=1`$ day. We find a power-law dependence of the standard deviation of the returns on the market capitalization, with exponent $`\beta 0.2`$ very similar to the values reported for the annual sales of firms, the GDP of countries and the university research budgets. For larger time scales the exponent gradually decreases, approaching the value $`\beta 0.09`$ for $`\mathrm{\Delta }t`$= 1000 days.