Volatility, Long Memory, and Chaos: A Discussion on some “Stylized Facts” in Financial Markets with a Focus on High Frequency Data

Abstract

Starting from the “Tulip Mania’ in the seventeenth century, financial sector crises have come in waves and in many different guises. While some of these remained confined to the regional boundaries, some acquired global dimension with the ultimate devastating impact on the real economy. The fact that the global economy has collapsed many a time following a financial panic has instigated the researchers, particularly after the recent global financial melt down, to explore the dynamics of global financial markets: the old issue of ‘finance-growth nexus’ is resurrected once again. The traditional school of the literature, however, is bifurcated on the issue. While one school perceives finance to be a ‘side show’ of growth, others believe in the considerable control that financial markets exercise on the real sector. The true nature and direction of the causality, however, is yet to be exposed. More recently, a parallel school of thought has developed that concentrate on the endogenous factors that generate dynamics within the stock market independent of the real sector. This growing body of the literature conjectures the global financial markets to be mostly deterministic, and in some cases, chaotic in nature. The markets are characterized by nonperiodic cycles and trends where volatility and fluctuations generate endogenously. The global markets, thus, are supposed to be inherently instable, or at best, stable on knife edge. Cycles and crashes are manifestations of this inherent instability. There is no determinate equilibrium in the market and no external shocks would be required to gear financial crises at regular interval. The implications of these are tremendous. A chaotic financial market puts efficient market hypothesis on trial, renders traditional asset pricing models useless, and makes long-term forecasting less reliable. The most devastating implication of the fact that the financial markets implode from within is perhaps for the developing markets as it makes government intervention ineffective. Hence, an introspection of financial market dynamics following this rather offbeat line of thought could be a researcher’s delight. The results obtained might lead to a reframing of old ideas and beliefs regarding financial market dynamics, boom and bust cycle, and predictability of financial crashes.