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Markov Processes, Hurst Exponents, and Nonlinear Diffusion Equations with application to finance

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  • Kevin E. Bassler
  • Gemunu H. Gunaratne
  • Joseph L. McCauley

Abstract

We show by explicit closed form calculations that a Hurst exponent H that is not 1/2 does not necessarily imply long time correlations like those found in fractional Brownian motion. We construct a large set of scaling solutions of Fokker-Planck partial differential equations where H is not 1/2. Thus Markov processes, which by construction have no long time correlations, can have H not equal to 1/2. If a Markov process scales with Hurst exponent H then it simply means that the process has nonstationary increments. For the scaling solutions, we show how to reduce the calculation of the probability density to a single integration once the diffusion coefficient D(x,t) is specified. As an example, we generate a class of student-t-like densities from the class of quadratic diffusion coefficients. Notably, the Tsallis density is one member of that large class. The Tsallis density is usually thought to result from a nonlinear diffusion equation, but instead we explicitly show that it follows from a Markov process generated by a linear Fokker-Planck equation, and therefore from a corresponding Langevin equation. Having a Tsallis density with H not equal to 1/2 therefore does not imply dynamics with correlated signals, e.g., like those of fractional Brownian motion. A short review of the requirements for fractional Brownian motion is given for clarity, and we explain why the usual simple argument that H unequal to 1/2 implies correlations fails for Markov processes with scaling solutions. Finally, we discuss the question of scaling of the full Green function g(x,t;x',t') of the Fokker-Planck pde.

Suggested Citation

  • Kevin E. Bassler & Gemunu H. Gunaratne & Joseph L. McCauley, 2006. "Markov Processes, Hurst Exponents, and Nonlinear Diffusion Equations with application to finance," Papers cond-mat/0602316, arXiv.org.
  • Handle: RePEc:arx:papers:cond-mat/0602316
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    Cited by:

    1. Vygintas Gontis, 2021. "Order flow in the financial markets from the perspective of the Fractional L\'evy stable motion," Papers 2105.02057, arXiv.org, revised Nov 2021.
    2. Sensoy, Ahmet & Tabak, Benjamin M., 2016. "Dynamic efficiency of stock markets and exchange rates," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 353-371.
    3. Risso, Wiston Adrián, 2008. "The informational efficiency and the financial crashes," Research in International Business and Finance, Elsevier, vol. 22(3), pages 396-408, September.
    4. Zunino, Luciano & Bariviera, Aurelio F. & Guercio, M. Belén & Martinez, Lisana B. & Rosso, Osvaldo A., 2016. "Monitoring the informational efficiency of European corporate bond markets with dynamical permutation min-entropy," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 456(C), pages 1-9.
    5. Gontis, V. & Kononovicius, A., 2017. "Burst and inter-burst duration statistics as empirical test of long-range memory in the financial markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 483(C), pages 266-272.
    6. Aleksejus Kononovicius & Vygintas Gontis, 2019. "Approximation of the first passage time distribution for the birth-death processes," Papers 1902.00924, arXiv.org.
    7. Zunino, Luciano & Tabak, Benjamin M. & Serinaldi, Francesco & Zanin, Massimiliano & Pérez, Darío G. & Rosso, Osvaldo A., 2011. "Commodity predictability analysis with a permutation information theory approach," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 390(5), pages 876-890.
    8. Kelty-Stephen, Damian G. & Mangalam, Madhur, 2024. "Additivity suppresses multifractal nonlinearity due to multiplicative cascade dynamics," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 637(C).
    9. Zunino, Luciano & Zanin, Massimiliano & Tabak, Benjamin M. & Pérez, Darío G. & Rosso, Osvaldo A., 2009. "Forbidden patterns, permutation entropy and stock market inefficiency," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(14), pages 2854-2864.
    10. Mynhardt, H. R. & Plastun, Alex & Makarenko, Inna, 2014. "Behavior of Financial Markets Efficiency During the Financial Market Crisis: 2007-2009," MPRA Paper 58942, University Library of Munich, Germany.
    11. Rytis Kazakevicius & Aleksejus Kononovicius & Bronislovas Kaulakys & Vygintas Gontis, 2021. "Understanding the nature of the long-range memory phenomenon in socioeconomic systems," Papers 2108.02506, arXiv.org, revised Aug 2021.
    12. Zunino, Luciano & Zanin, Massimiliano & Tabak, Benjamin M. & Pérez, Darío G. & Rosso, Osvaldo A., 2010. "Complexity-entropy causality plane: A useful approach to quantify the stock market inefficiency," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(9), pages 1891-1901.
    13. Sensoy, Ahmet & Tabak, Benjamin M., 2015. "Time-varying long term memory in the European Union stock markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 436(C), pages 147-158.
    14. Morales, Javier & Tercero, Víctor & Camacho-Vallejo, José-Fernando & Cordero, Alvaro E. & López Nerio, Luis E. & Almaguer, F-Javier, 2016. "Trend and fractality assessment of Mexico’s stock exchange," Applied Mathematics and Computation, Elsevier, vol. 285(C), pages 103-113.
    15. Seemann, Lars & Hua, Jia-Chen & McCauley, Joseph L. & Gunaratne, Gemunu H., 2012. "Ensemble vs. time averages in financial time series analysis," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(23), pages 6024-6032.
    16. Javier Morales & V'ictor Tercero & Fernando Camacho & Eduardo Cordero & Luis L'opez & F-Javier Almaguer, 2014. "Trend and Fractality Assessment of Mexico's Stock Exchange," Papers 1411.3399, arXiv.org.
    17. Sensoy, Ahmet & Fabozzi, Frank J. & Eraslan, Veysel, 2017. "Predictability dynamics of emerging sovereign CDS markets," Economics Letters, Elsevier, vol. 161(C), pages 5-9.
    18. Wiston Adrian Risso, 2009. "The informational efficiency: the emerging markets versus the developed markets," Applied Economics Letters, Taylor & Francis Journals, vol. 16(5), pages 485-487.
    19. Seemann, Lars & McCauley, Joseph L. & Gunaratne, Gemunu H., 2011. "Intraday volatility and scaling in high frequency foreign exchange markets," International Review of Financial Analysis, Elsevier, vol. 20(3), pages 121-126, June.
    20. Sensoy, Ahmet & Aras, Guler & Hacihasanoglu, Erk, 2015. "Predictability dynamics of Islamic and conventional equity markets," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 222-248.
    21. Vygintas Gontis, 2023. "Discrete $q$-exponential limit order cancellation time distribution," Papers 2306.00093, arXiv.org, revised Oct 2023.
    22. Miśkiewicz, Janusz & Ausloos, Marcel, 2008. "Correlation measure to detect time series distances, whence economy globalization," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(26), pages 6584-6594.
    23. Vygintas Gontis & Aleksejus Kononovicius, 2017. "Spurious memory in non-equilibrium stochastic models of imitative behavior," Papers 1707.09801, arXiv.org.
    24. V. Gontis & A. Kononovicius, 2017. "Burst and inter-burst duration statistics as empirical test of long-range memory in the financial markets," Papers 1701.01255, arXiv.org.
    25. Hua, Jia-Chen & Chen, Lijian & Falcon, Liberty & McCauley, Joseph L. & Gunaratne, Gemunu H., 2015. "Variable diffusion in stock market fluctuations," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 419(C), pages 221-233.

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