Stochastic modelling of financial time series with memory and multifractal scaling

Financial processes may possess long memory and their probability densities may display heavy tails. Many models have been developed to deal with this tail behaviour, which reflects the jumps in the sample paths. On the other hand, the presence of long memory, which contradicts the efficient market hypothesis, is still an issue for further debates. These difficulties present challenges with the problems of memory detection and modelling the co-presence of long memory and heavy tails. This PhD project aims to respond to these challenges. The first part aims to detect memory in a large number of financial time series on stock prices and exchange rates using their scaling properties. Since financial time series often exhibit stochastic trends, a common form of nonstationarity, strong trends in the data can lead to false detection of memory. We will take advantage of a technique known as multifractal detrended fluctuation analysis (MF-DFA) that can systematically eliminate trends of different orders. This method is based on the identification of scaling of the q-th-order moments and is a generalisation of the standard detrended fluctuation analysis (DFA) which uses only the second moment; that is, q = 2. We also consider the rescaled range R/S analysis and the periodogram method to detect memory in financial time series and compare their results with the MF-DFA. An interesting finding is that short memory is detected for stock prices of the American Stock Exchange (AMEX) and long memory is found present in the time series of two exchange rates, namely the French franc and the Deutsche mark. Electricity price series of the five states of Australia are also found to possess long memory. For these electricity price series, heavy tails are also pronounced in their probability densities. The second part of the thesis develops models to represent short-memory and longmemory financial processes as detected in Part I. These models take the form of continuous-time AR(∞) -type equations whose kernel is the Laplace transform of a finite Borel measure. By imposing appropriate conditions on this measure, short memory or long memory in the dynamics of the solution will result. A specific form of the models, which has a good MA(∞) -type representation, is presented for the short memory case. Parameter estimation of this type of models is performed via least squares, and the models are applied to the stock prices in the AMEX, which have been established in Part I to possess short memory. By selecting the kernel in the continuous-time AR(∞) -type equations to have the form of Riemann-Liouville fractional derivative, we obtain a fractional stochastic differential equation driven by Brownian motion. This type of equations is used to represent financial processes with long memory, whose dynamics is described by the fractional derivative in the equation. These models are estimated via quasi-likelihood, namely via a continuoustime version of the Gauss-Whittle method. The models are applied to the exchange rates and the electricity prices of Part I with the aim of confirming their possible long-range dependence established by MF-DFA. The third part of the thesis provides an application of the results established in Parts I and II to characterise and classify financial markets. We will pay attention to the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), the NASDAQ Stock Exchange (NASDAQ) and the Toronto Stock Exchange (TSX). The parameters from MF-DFA and those of the short-memory AR(∞) -type models will be employed in this classification. We propose the Fisher discriminant algorithm to find a classifier in the two and three-dimensional spaces of data sets and then provide cross-validation to verify discriminant accuracies. This classification is useful for understanding and predicting the behaviour of different processes within the same market. The fourth part of the thesis investigates the heavy-tailed behaviour of financial processes which may also possess long memory. We consider fractional stochastic differential equations driven by stable noise to model financial processes such as electricity prices. The long memory of electricity prices is represented by a fractional derivative, while the stable noise input models their non-Gaussianity via the tails of their probability density. A method using the empirical densities and MF-DFA will be provided to estimate all the parameters of the model and simulate sample paths of the equation. The method is then applied to analyse daily spot prices for five states of Australia. Comparison with the results obtained from the R/S analysis, periodogram method and MF-DFA are provided. The results from fractional SDEs agree with those from MF-DFA, which are based on multifractal scaling, while those from the periodograms, which are based on the second order, seem to underestimate the long memory dynamics of the process. This highlights the need and usefulness of fractal methods in modelling non-Gaussian financial processes with long memory.

Multifractal analysis of geomagnetic storm and solar flare indices and their class dependence

The multifractal properties of two indices of geomagnetic activity, D st (representative of low latitudes) and a p (representative of the global geomagnetic activity), with the solar X-ray brightness, X l , during the period from 1 March 1995 to 17 June 2003 are examined using multifractal detrended fluctuation analysis (MF-DFA). The h(q) curves of D st and a p in the MF-DFA are similar to each other, but they are different from that of X l , indicating that the scaling properties of X l are different from those of D st and a p . Hence, one should not predict the magnitude of magnetic storms directly from solar X-ray observations. However, a strong relationship exists between the classes of the solar X-ray irradiance (the classes being chosen to separate solar flares of class X-M, class C, and class B or less, including no flares) in hourly measurements and the geomagnetic disturbances (large to moderate, small, or quiet) seen in D st and a p during the active period. Each time series was converted into a symbolic sequence using three classes. The frequency, yielding the measure representations, of the substrings in the symbolic sequences then characterizes the pattern of space weather events. Using the MF-DFA method and traditional multifractal analysis, we calculate the h(q), D(q), and τ (q) curves of the measure representations. The τ (q) curves indicate that the measure representations of these three indices are multifractal. On the basis of this three-class clustering, we find that the h(q), D(q), and τ (q) curves of the measure representations of these three indices are similar to each other for positive values of q. Hence, a positive flare storm class dependence is reflected in the scaling exponents h(q) in the MF-DFA and the multifractal exponents D(q) and τ (q). This finding indicates that the use of the solar flare classes could improve the prediction of the D st classes.

Multifractal characterisation and analysis of complex networks

Complex networks have been studied extensively due to their relevance to many real-world systems such as the world-wide web, the internet, biological and social systems. During the past two decades, studies of such networks in different fields have produced many significant results concerning their structures, topological properties, and dynamics. Three well-known properties of complex networks are scale-free degree distribution, small-world effect and self-similarity. The search for additional meaningful properties and the relationships among these properties is an active area of current research. This thesis investigates a newer aspect of complex networks, namely their multifractality, which is an extension of the concept of selfsimilarity. The first part of the thesis aims to confirm that the study of properties of complex networks can be expanded to a wider field including more complex weighted networks. Those real networks that have been shown to possess the self-similarity property in the existing literature are all unweighted networks. We use the proteinprotein interaction (PPI) networks as a key example to show that their weighted networks inherit the self-similarity from the original unweighted networks. Firstly, we confirm that the random sequential box-covering algorithm is an effective tool to compute the fractal dimension of complex networks. This is demonstrated on the Homo sapiens and E. coli PPI networks as well as their skeletons. Our results verify that the fractal dimension of the skeleton is smaller than that of the original network due to the shortest distance between nodes is larger in the skeleton, hence for a fixed box-size more boxes will be needed to cover the skeleton. Then we adopt the iterative scoring method to generate weighted PPI networks of five species, namely Homo sapiens, E. coli, yeast, C. elegans and Arabidopsis Thaliana. By using the random sequential box-covering algorithm, we calculate the fractal dimensions for both the original unweighted PPI networks and the generated weighted networks. The results show that self-similarity is still present in generated weighted PPI networks. This implication will be useful for our treatment of the networks in the third part of the thesis. The second part of the thesis aims to explore the multifractal behavior of different complex networks. Fractals such as the Cantor set, the Koch curve and the Sierspinski gasket are homogeneous since these fractals consist of a geometrical figure which repeats on an ever-reduced scale. Fractal analysis is a useful method for their study. However, real-world fractals are not homogeneous; there is rarely an identical motif repeated on all scales. Their singularity may vary on different subsets; implying that these objects are multifractal. Multifractal analysis is a useful way to systematically characterize the spatial heterogeneity of both theoretical and experimental fractal patterns. However, the tools for multifractal analysis of objects in Euclidean space are not suitable for complex networks. In this thesis, we propose a new box covering algorithm for multifractal analysis of complex networks. This algorithm is demonstrated in the computation of the generalized fractal dimensions of some theoretical networks, namely scale-free networks, small-world networks, random networks, and a kind of real networks, namely PPI networks of different species. Our main finding is the existence of multifractality in scale-free networks and PPI networks, while the multifractal behaviour is not confirmed for small-world networks and random networks. As another application, we generate gene interactions networks for patients and healthy people using the correlation coefficients between microarrays of different genes. Our results confirm the existence of multifractality in gene interactions networks. This multifractal analysis then provides a potentially useful tool for gene clustering and identification. The third part of the thesis aims to investigate the topological properties of networks constructed from time series. Characterizing complicated dynamics from time series is a fundamental problem of continuing interest in a wide variety of fields. Recent works indicate that complex network theory can be a powerful tool to analyse time series. Many existing methods for transforming time series into complex networks share a common feature: they define the connectivity of a complex network by the mutual proximity of different parts (e.g., individual states, state vectors, or cycles) of a single trajectory. In this thesis, we propose a new method to construct networks of time series: we define nodes by vectors of a certain length in the time series, and weight of edges between any two nodes by the Euclidean distance between the corresponding two vectors. We apply this method to build networks for fractional Brownian motions, whose long-range dependence is characterised by their Hurst exponent. We verify the validity of this method by showing that time series with stronger correlation, hence larger Hurst exponent, tend to have smaller fractal dimension, hence smoother sample paths. We then construct networks via the technique of horizontal visibility graph (HVG), which has been widely used recently. We confirm a known linear relationship between the Hurst exponent of fractional Brownian motion and the fractal dimension of the corresponding HVG network. In the first application, we apply our newly developed box-covering algorithm to calculate the generalized fractal dimensions of the HVG networks of fractional Brownian motions as well as those for binomial cascades and five bacterial genomes. The results confirm the monoscaling of fractional Brownian motion and the multifractality of the rest. As an additional application, we discuss the resilience of networks constructed from time series via two different approaches: visibility graph and horizontal visibility graph. Our finding is that the degree distribution of VG networks of fractional Brownian motions is scale-free (i.e., having a power law) meaning that one needs to destroy a large percentage of nodes before the network collapses into isolated parts; while for HVG networks of fractional Brownian motions, the degree distribution has exponential tails, implying that HVG networks would not survive the same kind of attack.