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Stochastic SO (2) Lie Group Method for Approximating Correlation Matrices

Author

Listed:
  • Melike Bildirici

    (Department of Economics, Yildiz Technical University, Istanbul 34210, Türkiye)

  • Yasemen Ucan

    (Mathematical Engineering, Yildiz Technical University, Istanbul 34210, Türkiye)

  • Ramazan Tekercioglu

    (Mathematical Engineering, Yildiz Technical University, Istanbul 34210, Türkiye)

Abstract

Standard correlation analysis is one of the frequently used methods in financial markets. However, this matrix can give erroneous results in the conditions of chaos, fractional systems, entropy, and complexity for the variables. In this study, we employed the time-dependent correlation matrix based on isospectral flow using the Lie group method to assess the price of Bitcoin and gold from 19 July 2010 to 31 December 2024. Firstly, we showed that the variables have a chaotic and fractional structure. Lo’s rescaled range (R/S) and the Mandelbrot–Wallis method were used to determine fractionality and long-term dependence. We estimated and tested the d parameter using GPH and Phillips’ estimators. Renyi, Shannon, Tsallis, and HCT tests determined entropy. The KSC determined the evidence of the complexity of the variables. Hurst exponents determined mean reversion, chaos, and Brownian motion. Largest Lyapunov and Hurst exponents and entropy methods and KSC found evidence of chaos, mean reversion, Brownian motion, entropy, and complexity. The BDS test determined nonlinearity, and later, the time-dependent correlation matrix was obtained by using the stochastic SO (2) Lie group. Finally, we obtained robustness check results. Our results showed that the time-dependent correlation matrix obtained by using the stochastic SO (2) Lie group method yielded more successful results than the ordinary correlation and covariance matrix and the Spearman correlation and covariance matrix. If policymakers, financial managers, risk managers, etc., use the standard correlation method for economy or financial policies, risk management, and financial decisions, the effects of nonlinearity, fractionality, entropy, and chaotic structures may not be fully evaluated or measured. In such cases, this can lead to erroneous investment decisions, bad portfolio decisions, and wrong policy recommendations.

Suggested Citation

  • Melike Bildirici & Yasemen Ucan & Ramazan Tekercioglu, 2025. "Stochastic SO (2) Lie Group Method for Approximating Correlation Matrices," Mathematics, MDPI, vol. 13(9), pages 1-16, April.
    • Handle: RePEc:gam:jmathe:v:13:y:2025:i:9:p:1496-:d:1647341
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    References listed on IDEAS

    as
    1. Melike Bildirici & Yasemen Ucan & Sérgio Lousada, 2022. "Interest Rate Based on The Lie Group SO(3) in the Evidence of Chaos," Mathematics, MDPI, vol. 10(21), pages 1-9, October.
    2. C. F. Lo & C. H. Hui, 2001. "Valuation of financial derivatives with time-dependent parameters: Lie-algebraic approach," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 73-78.
    3. Kapetanios, George & Shin, Yongcheol & Snell, Andy, 2003. "Testing for a unit root in the nonlinear STAR framework," Journal of Econometrics, Elsevier, vol. 112(2), pages 359-379, February.
    4. Vineer Bhansali & Mark B. Wise, 2001. "Forecasting Portfolio Risk in Normal and Stressed Markets," Papers nlin/0108022, arXiv.org, revised Sep 2001.
    5. Michelle Muniz & Matthias Ehrhardt & Michael Günther, 2021. "Approximating Correlation Matrices Using Stochastic Lie Group Methods," Mathematics, MDPI, vol. 9(1), pages 1-10, January.
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