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Multifractality of US Dollar/Deutsche Mark Exchange Rates

Laurent Calvet (), Benoît Mandelbrot and Adlai J. Fisher
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Adlai J. Fisher: Sauder - Sauder School of Business [British Columbia] - UBC - University of British Columbia

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Abstract: This paper presents the first empirical investigation of the Multifractal Model of Asset Returns ("MMAR"). The MMAR, developed in Mandelbrot, Fisher, and Calvet (1997), is an alternative to ARCH-type representations for modelling temporal heterogeneity in financial returns. Typically, researchers introduce temporal heterogeneity through time-varying conditional second moments in a discrete time framework. Multifractality introduces a new source of heterogeneity through time-varying local regularity in the price path. The concept of local Holder exponent describes local regularity. Multifractal processes bridge the gap between locally Gaussian (Ito) diffusions and jump-diffusions by allowing a multiplicity of Holder exponents. This paper investigates multifractality in Deutschemark/US Dollar currency exchange rates. After finding evidence of multifractal scaling, we show how to estimate the multifractal spectrum via the Legendre transform. The scaling laws found in the data are replicated in simulations. Further simulation experiments test whether alternative representations, such as FIGARCH, are likely to replicate the multifractal signature of the Deutschemark/US Dollar data. On the basis of this evidence, the MMAR hypothesis appears more likely. Overall, the MMAR is quite successful in uncovering a previously unseen empirical regularity. Additionally, the model generates realistic sample paths, and opens the door to new theoretical and applied approaches to asset pricing and risk valuation. We conclude by advocating further empirical study of multifractality in financial data, along with more intensive study of estimation techniques and inference procedures.

Keywords: self-affinity; self-similarity; multiscaling; scaling laws; time deformation; compound stochastic process; trading time; multifractal process; Multifractal model of asset returns (search for similar items in EconPapers)
Date: 2011-06-21
Note: View the original document on HAL open archive server: https://hal-hec.archives-ouvertes.fr/hal-00601871
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Published in 2011

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