Jour of Adv Research in Dynamical & Control Systems, May 2017

Special Issue on Recent Trends in Engineering and Managerial Excellence

Modeling BSE SENSEX Using Multi Fractal

Model of Asset Returns
P. Dhanu, Assistant Professor, Sri Ganesh School of Business Management, Salem.
Dr.R. Velmurugan, Associate Professor, Department of Commerce, Karpagam University, Karpagam Academy of Higher
Education, Coimbatore, Tamilnadu, India. E-mail:drvelsngm@gmail.com
Abstract--- This paper tries to apply Multifractal Model of Asset Returns (MMAR) to model the BSE SENSEX. In
this model, the parameter Hurst exponent is estimated from the BSE SENSEX. MMAR is simulated using 𝑋𝑋(𝑡𝑡) =
𝐵𝐵𝐻𝐻 [(𝜃𝜃(𝑡𝑡)] a compound process of fractional Brownian Motion by cumulative distribution function of binomial
measure. MMAR is able to generate volatility clustering and fat tails that are empirically observed.

I. Introduction
Multifractal model of asset returns (MMAR)is a model proposed by Benoit Mandelbrot which is an extension of
his earlier work on fractional Brownian motion (FBM) and levi stable distribution to model asset prices. Another
important element in the MMAR is the idea of trading time invented by Mandelbrot and Taylor (1967). The most
important feature of trading time is clear modeling of the relationship between unobserved natural time-scale of the
returns process, and clock time, which is what we observe.
Self-affine Process
If the fractal pieces are scaled by different amounts in x and y direction then it is called self-affinity. Mandelbrot
(1963, 1967), followed by Fama (1963), suggested that the shape of the distribution of returns should be the same
when the time scale is changed.
Definition Granted X(0)=0, a random process {X(t) that satisfies :

{𝑋𝑋(𝑐𝑐𝑡𝑡1 ), … . . , 𝑋𝑋(𝑐𝑐𝑡𝑡𝑘𝑘 )} 𝑑𝑑 {𝑐𝑐 𝐻𝐻 𝑋𝑋(𝑡𝑡1 ), … . . , 𝑐𝑐 𝐻𝐻 𝑋𝑋(𝑡𝑡𝑘𝑘 )}

=
For some H>0 and all c, k, t1 , … . . t n ≥ 0 is called as self-affine
Two important self-affine processes that have been used in finance are Lévy stable distribution and FBM.
Multifractality
Multifractals follow a scaling rule
𝑑𝑑
𝑋𝑋(𝑐𝑐𝑐𝑐) 𝑀𝑀(𝑐𝑐)𝑋𝑋(𝑡𝑡)
=
Where X and M are independent random functions
Simulating Multifractal Process
Multifractal process is generated by
𝑋𝑋(𝑡𝑡) = 𝐵𝐵𝐻𝐻 [(𝜃𝜃(𝑡𝑡)]
It is generated by compounding fractional Brownian motion 𝐵𝐵𝐻𝐻 (𝑡𝑡) by cumulative distribution function θ(t) of a
multifractal measure.
Definition of Multifractal Process
A stochastic process {X(t)} is called multifractal process if it has stationary increments and satisfies
𝐸𝐸(|𝑋𝑋(𝑡𝑡)|𝑞𝑞 = 𝑐𝑐(𝑞𝑞)𝑡𝑡 𝜏𝜏(𝑞𝑞)+1 , for all 𝑡𝑡 ∈ 𝑇𝑇, 𝑞𝑞 ∈ 𝑄𝑄
Where T and Q are intervals on the real line. 𝜏𝜏(𝑞𝑞)𝑎𝑎𝑎𝑎𝑎𝑎 𝑐𝑐(𝑞𝑞) are functions with domain Q. Moreover, we assume
that T and Q have positive lengths 0 ∈ 𝑇𝑇, [0,1] ⊆ 𝑄𝑄
Multifractal Model of Asset Returns
In this session, we discuss how multifractal is used to model the asset prices
{𝑃𝑃(𝑡𝑡); 0 ≤ 𝑡𝑡 ≤ 𝑇𝑇}
𝑋𝑋(𝑡𝑡) = ln 𝑃𝑃(𝑡𝑡) − ln 𝑃𝑃(0)

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Jour of Adv Research in Dynamical & Control Systems, May 2017
Special Issue on Recent Trends in Engineering and Managerial Excellence

The assumptions of the multifractal model are:

1. X(t) is a compound Process:
𝑋𝑋(𝑡𝑡) ≡ 𝐵𝐵𝐻𝐻 [𝜃𝜃(𝑡𝑡)]
Where 𝐵𝐵𝐻𝐻 (𝑡𝑡) is a fractional Brownian motion with self-affinity index H, and θ(t) is stochastic trading time.
2. The trading time θ(t) is cumulative distribution function of multifractal measure defined on [0, T]. That is
θ(t) is a multifractal process with continuous, non-decreasing paths and stationary increments.
{BH(t)} and {θ(t)} are independent
The graph 1 is generated using MATLAB. It is modeling the stock market fluctuations. The parameters are Hurst
exponent H =0.615; mean value of lognormal BSE SENSEX returns (ln_µ) = 0.00007293; standard deviation of
lognormal returns (ln_σ) = 0.00211318 . it is showing serial dependency, that means price fluctuations are related as
opposed to (i.i.d) independent and identically distributed. It also displays huge changes in price fluctuations or fat
tails.

200

150

100

50

-50

-100
0 1000 2000 3000 4000 5000 6000 7000 8000 9000

Graph 1: Simulation of MMAR

The graph 1.1 is generated using MATLAB software. It is modeling the stock market fluctuations. The
parameters are Hurst exponent H =0.615; mean value of lognormal BSE SENSEX returns (ln_µ) = 0.000072;
standard deviation of lognormal returns (ln_σ) = 0.002113. it is showing serial dependency, that means price
fluctuations are related as opposed to (i.i.d) independent and identically distributed. It also displays huge changes in
price fluctuations.
The (Graph 2) is price change of MMAR and it is showing all the features of stock market fluctuations. It can
observe the volatility clustering that is, huge changes are clustered and small changes are clustered in different time
period. The model has incorporated the long-term dependency and fat tails that are observed in daily log returns of
BSE SENSEX from 1992 to 2015 (Graph 3).

Graph 2: Return of MMAR

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Jour of Adv Research in Dynamical & Control Systems, May 2017
Special Issue on Recent Trends in Engineering and Managerial Excellence

Graph 3: Daily Log Return of BSE SENSEX (From 1992 to 2015)

II. Findings
The simulated figure (Graph 2) and the log return of BSE SENSEX (Graph 3) figure are looking very similar.
Both of them are exhibiting volatility clustering that is huge deviation is clustered together, that is period of high
volatility and low volatility. This MMAR model is showing long range dependence as shown by FBM and the large
deviation observed in Lévy stable distribution.

III. Conclusion
MMAR is the showing all the signs of being a superior model that is fitting the observation better than the
previous models. The model is simple with only one parameter the Hurst exponent and also has least number of
assumptions compared to other econometric models.

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Special Issue on Recent Trends in Engineering and Managerial Excellence

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