Large Deviations and the Distribution of Price Changes

Calvet, Laurent E., Fisher, Adlai J. and Mandelbrot, Benoit B., "Large Deviations and the Distribution of Price Changes" (September 15, 1997). Cowles Foundation Discussion Paper No. 1165.

Abstract:

The Multifractal Model of Asset Returns (See Mandelbrot, Fisher, and Calvet, 1997 ) proposes a class of multifractal processes for the modelling of financial returns. In that paper, multifractal processes are defined by a scaling law for moments of the processes' increments over finite time intervals. In the present paper, we discuss the local behavior of multifractal processes. We employ local Holder exponents, a fundamental concept in real analysis that describes the local scaling properties of a realized path at any point in time. In contrast with the standard models of continuous time finance, multifractal processes contain a multiplicity of local Holder exponents within any finite time interval. We characterize the distribution of Holder exponents by the multifractal spectrum of the process. For a broad class of multifractal processes, this distribution can be obtained by an application of Cramer's Large Deviation Theory. In an alternative interpretation, the multifractal spectrum describes the fractal dimension of the set of points having a given local Holder exponent. Finally, we show how to obtain processes with varied spectra. This allows the applied researcher to relate an empirical estimate of the multifractal spectrum back to a particular construction of the stochastic process.

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