Statistical Mechanics of Financial Markets (SMFM)

Lester Ingber
Lester Ingber Research
POB 06440
Wacker Dr PO Sears Tower
Chicago, IL 60606
ingber@ingber.com ingber@alumni.caltech.edu
and
DRWInv estments LLC
Chicago Mercantile Exchange Center
30 S Wacker Dr Ste 1516
Chicago, IL 60606
ingber@drwtrading.com
MATHEMATICAL PHYSICS
NUMERICAL ALGORITHMS
SOME FINANCIAL APPLICATIONS
SOME OUT-OF-FINANCE LESSONS LEARNED
SOME CURRENT PROJECTS
The latest Adaptive Simulated Annealing (ASA) code and related reprints can be
retrieved via WWW from http://www.ingber.com/ or via FTP from ftp.ingber.com.
$Id: markets_lecture,v 1.15 1999/04/17 12:52:45 ingber Exp ingber $
SMFM Lester Ingber
Statistical Mechanics of Financial Markets (SMFM)
MATHEMATICAL PHYSICS . . . . . . . . . . . . . . . 4
Nonlinear Nonequilibrium Multivariate Stochastic Aggregation . . . 5
Stochastic Differential Equation (SDE) . . . . . . . . . . 6
Partial Differential Equation (PDE) . . . . . . . . . . . . 7
Lagrangian Probability Distribution Function (PDF) . . . . . . 8
Path-Integral Riemannian Geometry . . . . . . . . . . . 9
Information . . . . . . . . . . . . . . . . . . . 10
Transformations Without Ito Calculus . . . . . . . . . . . 11
Intuitive Variables . . . . . . . . . . . . . . . . . 12
Euler-Lagrange Variational Equations . . . . . . . . . . . 13
Canonical Momenta Indicators (CMI) . . . . . . . . . . . 14
Generic Mesoscopic Neural Networks (MNN) . . . . . . . . 15
MNN Learning . . . . . . . . . . . . . . . . 16
MNN Prediction . . . . . . . . . . . . . . . 17
MNN Parallel Processing . . . . . . . . . . . . . 18
NUMERICAL ALGORITHMS . . . . . . . . . . . . . . . 19
Adaptive Simulated Annealing (ASA) . . . . . . . . . . . 20
Hills and Valleys . . . . . . . . . . . . . . . 21
Outline of ASA Algorithm . . . . . . . . . . . . 22
Index of Pre-Compile Tuning Parameters . . . . . . . . 23
Index of Adaptive Tuning Parameters . . . . . . . . . 24
Reannealing Example . . . . . . . . . . . . . . 25
Example: Fitting Variance . . . . . . . . . . . . 26
Numerical Path Integration (PATHINT) . . . . . . . . . . 27
Outline of PATHINT Algorithm . . . . . . . . . . . 28
Boundary Condition Sensitivity . . . . . . . . . . . 29
Mesh Limitations . . . . . . . . . . . . . . . 30
SOME FINANCIAL APPLICATIONS . . . . . . . . . . . . 31
Risk-Averting Agents . . . . . . . . . . . . . . . . 32
Aggregation of Risk-Averting Agents . . . . . . . . . . . 33
Interest Rates . . . . . . . . . . . . . . . . . . 34
2-Factor Interest-Rate Model . . . . . . . . . . . . 35
Lagrangian Representation . . . . . . . . . . . . 36
ASA Fits . . . . . . . . . . . . . . . . . . 37
Bond PDE/PATHINT . . . . . . . . . . . . . . 38
S&P . . . . . . . . . . . . . . . . . . . . . 39
S&P Interday Futures-Cash . . . . . . . . . . . . 40
Inner-Shell Dynamic Model . . . . . . . . . . . . 41
Outer-Shell Trading Model . . . . . . . . . . . . 42
Recursive ASA Fits . . . . . . . . . . . . . . 43
SMFM Lester Ingber
SOME OUT-OF-FINANCE LESSONS LEARNED . . . . . . . . 44
Statistical Mechanics of Combat (SMC) . . . . . . . . . . 45
National Training Center Janus(T) . . . . . . . . . 46
Basic Equations of Aggregated Units . . . . . . . . . 47
Long-Time Correlations Test Short-Time Models . . . . . 48
CMI . . . . . . . . . . . . . . . . . . . 49
Statistical Mechanics of Neocortical Interactions (SMNI) . . . . . 50
Basic SMNI . . . . . . . . . . . . . . . . . 51
Multiple Scales . . . . . . . . . . . . . . 52
Microscopic Aggregation . . . . . . . . . . . 53
Short-Term Memory (STM) . . . . . . . . . . . . 54
PDE Stability & Duration Analyses . . . . . . . 55
STM PATHINT Details . . . . . . . . . . . 56
Electroencephalography (EEG) . . . . . . . . . . . 57
ASA Fits of CMI . . . . . . . . . . . . . 58
Chaos in SMNI . . . . . . . . . . . . . . . . 59
Dufng Analog . . . . . . . . . . . . . . 60
Noise Washes Out Chaos/PATHINT . . . . . . . 61
SOME CURRENT PROJECTS . . . . . . . . . . . . . . . 62
Volatility Modeling . . . . . . . . . . . . . . . . . 63
Eurodollar Spreads . . . . . . . . . . . . . . . 64
Eurodollar Volatility of Historical Volatility . . . . . . . 65
Eurodollar Volatility of Implied Volatility . . . . . . . . 66
Power-Law Model . . . . . . . . . . . . . . . . . 67
Multi-Factor Volatility Model . . . . . . . . . . . 68
PATHINT . . . . . . . . . . . . . . . . . . 69
PATHINT Two-Factor . . . . . . . . . . . . . . 70
x Market Indicators . . . . . . . . . . . . . . . 71
Stochasticity: Volatility vs Exponent . . . . . . . . . 72
BS vs CRR vs PATHINT . . . . . . . . . . . . . 73
Tick Resolution CMI Trading . . . . . . . . . . . . . 74
SMFM Lester Ingber
MATHEMATICAL PHYSICS
SMFM Lester Ingber
Nonlinear Nonequilibrium Multivariate Stochastic Aggregation
Complex systems typically are in nonequilibrium, being driven by nonlinear and
stochastic interactions described by many external and internal degrees of freedom.
For these systems, classical thermodynamic descriptions typically do not apply.
Many such systems are best treated by respecting some intermediate mesoscale as
fundamental to drive larger macroscopic processes.
Often these mesoscopic scales are aptly described by Gaussian Markovian
statistics. They naturally develop in physical and biological scales to maximally
process information from microscopic scales up to macroscopic scales. Possibly
this is true as well of some social systems such as nancial markets.
For many physical systems this mesoscopic scale still has some audit trail back to
its microscopic origins. Often, statistical deviations of drift variables lead to
functional dependencies in diffusion variables.
SMFM Lester Ingber
Stochastic Differential Equation (SDE)
The Stratonovich (midpoint discretized) Langevin equations can be analyzed in
terms of the Wiener process dW
i
, which can be rewritten in terms of Gaussian
noise
i
dW
i
/dt if care is taken in the limit.
dM
G
f
G
((t, M(t)))dt + g
G
i
((t, M(t)))dW
i
,

M
G
(t) f
G
((t, M(t))) + g
G
i
((t, M(t)))
i
(t) ,
dW
i

i
dt ,
M M
G
; G 1,
. . .
, ,

i
; i 1,
. . .
, N .

M
G
dM
G
/dt ,
<
j
(t) >

0 ,
<
j
(t),
j
(t) >

jj
(t t) ,

i
represents Gaussian white noise, and moments of an arbitrary function F()
over this stochastic space are dened by a path-type integral over
i
, folding time
increments t,
< F() >

N
1

DF() exp
j
,
(

1
2

t
0

dt
i

i
\
(
,
,
N

D exp
j
,
(

1
2

t
0

dt
i

i
\
(
,
,
D
v

lim
v+1
0

N
j1

(2 )
1/2
dW
j

,
t

t
0
+ ,
1
2

dt
i

1
2

(W
i

W
i
1
)
2
,
<
i
>

0 ,
<
i
(t)
j
(t) >

ij
(t t) .
SMFM Lester Ingber
Partial Differential Equation (PDE)
If some boundary conditions are added as Lagrange multipliers, these enter as a
potential V, creating a Schrodinger-type equation:
P
,t

1
2
(g
GG
P)
,GG
(g
G
P)
,G
+ VP ,
P < P

>

,
g
G
f
G
+
1
2
g
G
i
g
G
i,G
,
g
GG
g
G
i
g
G
i
,
(
. . .
)
,G
(
. . .
)/M
G
.
Note that g
G
replaces f
G
in the SDE if the Ito (prepoint discretized) calculus is
used to dene that equation.
SMFM Lester Ingber
Lagrangian Probability Distribution Function (PDF)
This can be transformed to the Stratonovich representation, in terms of the
Feynman Lagrangian L possessing a covariant variational principle,
P[M
t
| M
t
0
]dM(t)

. . .

DM exp
j
,
(
min
t
t
0

dtL
\
(
,
((M(t
0
) M
0
)) ((M(t) M
t
)) ,
DM
u

lim
u+1
1

g
1/2
G

(2 )
1/2
dM
G

,
L(

M
G
, M
G
, t)
1
2
(

M
G
h
G
)g
GG
(

M
G
h
G
) +
1
2
h
G
;G
+ R/6 V ,
[
. . .
]
,G

[
. . .
]
M
G
,
h
G
g
G

1
2
g
1/2
(g
1/2
g
GG
)
,G
,
g
GG
(g
GG
)
1
,
g det(g
GG
) ,
h
G
;G
h
G
,G
+
F
GF
h
G
g
1/2
(g
1/2
h
G
)
,G
,

F
JK
g
LF
[JK, L] g
LF
(g
JL,K
+ g
KL,J
g
JK,L
) ,
R g
JL
R
JL
g
JL
g
JK
R
FJKL
,
R
FJKL

1
2
(g
FK,JL
g
JK,FL
g
FL,JK
+ g
JL,FK
) + g
MN
(
M
FK

N
JL

M
FL

N
JK
) .
SMFM Lester Ingber
Path-Integral Riemannian Geometry
The midpoint derivation explicitly derives a Riemannian geometry induced by
these statistics, with a metric dened by the inverse of the covariance matrix
g
GG
(g
GG
)
1
,
and where R is the Riemannian curvature
R g
JL
R
JL
g
JL
g
JK
R
FJKL
,
An Ito prepoint discretization for the same probability distribution P gives a much
simpler algebraic form,
M(t
s
) M(t
s
) ,
L
1
2
(dM
G
/dt g
G
)g
GG
(dM
G
/dt g
G
) V ,
but the Lagrangian L so specied does not satisfy a variational principle as useful
for moderate to large noise; its associated variational principle only provides
information useful in the weak-noise limit. Numerically, this often means that
ner meshes are required for calculations for the prepoint representation.
SMFM Lester Ingber
Information
With reference to a steady state P(

M), when it exists, an analytic denition of the
information gain

in state

P(

M) is dened by

[

P]

. . .

D

M

P ln(

P/P),
where a path integral is dened such that all intermediate-time values of

M
appearing in the folded short-time distributions

P are integrated over. This is quite
general for any system that can be described as Gaussian-Markovian, even if only
in the short-time limit.
As time evolves, the distribution likely no longer behaves in a Gaussian manner,
and the apparent simplicity of the short-time distribution must be supplanted by
numerical calculations.
SMFM Lester Ingber
Transformations Without Ito Calculus
Consider
V[S, t + t | S, t] ((2 ( S)
2
t))
1/2
exp(L t) ,
L
(

S + rS)
2
2( S)
2
+ r ,

S
S
t

S(t + t) S(t)
t
.
Some care must be taken with nonconstant drifts and diffusions. For example, for
purposes of calculating volatilities, it is often convenient to transform to a variable
Z (S relative to some S scale)
Z ln S .
The above distribution can be transformed into V[Z, t + t|Z, t],
dS
t
V[S, t + t|S, t] dZ
t
V[Z, t + t|Z, t]
dZ
t
(2
2
t)
1/2
exp(L t) ,
L t
(([exp(Z
t+ t
Z
t
) 1] + r))
2
2
2
t
+ r t .
This can be expanded into
L t
((Z
t+ t
Z
t
+
1
2
(Z
t+ t
Z
t
)
2
r t)))
2
2
2
t
+ r t

((Z
t+ t
Z
t
(r
1
2

2
) t))
2
2
2
t
+ r t ,
(Z
t+ t
Z
t
)
2

2
t ,
where only terms of order t have been kept, yielding
L
j
(

Z (r
1
2

2
)
\
,
2
2
2
+ r .
SMFM Lester Ingber
Intuitive Variables
It must be emphasized that the output need not be conned to complex algebraic
forms or tables of numbers. Because L possesses a variational principle, sets of
contour graphs, at different long-time epochs of the path-integral of P over its
variables at all intermediate times, give a visually intuitive and accurate decision-
aid to view the dynamic evolution of the scenario. For example, this Lagrangian
approach permits a quantitative assessment of concepts usually only loosely
dened.
SMFM Lester Ingber
Euler-Lagrange Variational Equations
The Euler-Lagrange variational equations give rise to the familiar force law
F ma : L 0
L
M
G


t
L
(M
G
/t)
,
Force
L
M
G
,
Mass g
GG


2
L
(M
G
/t)(M
G
/t)
,
where M
G
are the variables and L is the Lagrangian. These physical entities
provide another form of intuitive, but quantitatively precise, presentation of these
analyses.
SMFM Lester Ingber
Canonical Momenta Indicators (CMI)
Canonical Momenta Indicators (CMI), dened by
Momentum
G

L
(M
G
/t)
,
can be used as nancial indicators faithful to an underlying mathematics modeling
markets as stochastic distributions.
SMFM Lester Ingber
Generic Mesoscopic Neural Networks (MNN)
Modern stochastic calculus permits development of alternative descriptions of
path-integral Lagrangians, Fokker-Planck equations, and Langevin rate equations.
The induced Riemannian geometry affords invariance of probability distribution
under general nonlinear transformations.
ASA presents a powerful global optimization that has been tested in a variety of
problems dened by nonlinear Lagrangians.
Parallel-processing computations can be applied to ASA as well as to a neural-
network architecture.
SMFM Lester Ingber
MNN Learning
Learning takes place by presenting the MNN with data, and parametrizing the
data in terms of the rings, or multivariate M
G
spins. The weights, or
coefcients of functions of M
G
appearing in the drifts and diffusions, are t to
incoming data, considering the joint effective Lagrangian (including the
logarithm of the prefactor in the probability distribution) as a dynamic cost
function.
The cost function is a sum of effective Lagrangians from each node and over each
time epoch of data.
This program of tting coefcients in Lagrangian uses methods of adaptive
simulated annealing (ASA). This maximum likelihood procedure (statistically)
avoids problems of trapping in local minima, as experienced by other types of
gradient and regression techniques.
SMFM Lester Ingber
MNN Prediction
Prediction takes advantage of a mathematically equivalent representation of the
Lagrangian path-integral algorithm, i.e., a set of coupled Langevin rate-equations.
The Ito (prepoint-discretized) Langevin equation is analyzed in terms of the
Wiener process dW
i
, which is rewritten in terms of Gaussian noise
i
dW
i
/dt in
the limit:
M
G
(t + t) M
G
(t) dM
G
g
G
dt + g
G
i
dW
i
,
dM
G
dt

M
G
g
G
+ g
G
i

i
,
M M
G
; G 1,
. . .
, ,
i
; i 1,
. . .
, N ,
<
j
(t) >

0 , <
j
(t),
j
(t) >

jj
(t t) .
Moments of an arbitrary function F() over this stochastic space are dened by a
path integral over
i
. The Lagrangian diffusions are calculated as
g
GG

N
i1

g
G
i
g
G
i
.
SMFM Lester Ingber
MNN Parallel Processing
The use of parallel processors can make this algorithm even more efcient, as ASA
lends itself well to parallelization.
During learning, blocks of random numbers are generated in parallel, and then
sequentially checked to nd a generating point satisfying all boundary conditions.
Advantage is taken of the low ratio of acceptance to generated points typical in
ASA, to generate blocks of cost functions, and then sequentially checked to nd
the next best current minimum.
Additionally, when tting dynamic systems, e.g., the three physical systems
examined to date, parallelization is attained by independently calculating each time
epochs contribution to the cost function.
Similarly, during prediction, blocks of random numbers are generated to support
the Langevin-equation calculations, and each node is processed in parallel.
SMFM Lester Ingber
NUMERICAL ALGORITHMS
SMFM Lester Ingber
Adaptive Simulated Annealing (ASA)
This algorithm ts empirical data to a theoretical cost function over a D-
dimensional parameter space, adapting for varying sensitivities of parameters
during the t.
For sev eral test problems, ASA has been shown to be orders of magnitude more
efcient than other similar techniques, e.g., genetic algorithms. ASA has been
applied to several complex systems, including specic problems in neuroscience,
nance and combat systems.
Heuristic arguments have been developed to demonstrate that this algorithm is
faster than the fast Cauchy annealing, T
i
T
0
/k, and much faster than Boltzmann
annealing, T
i
T
0
/ ln k.
SMFM Lester Ingber
Hills and Valleys
It helps to visualize the problems presented by such complex systems as a
geographical terrain. For example, consider a mountain range, with two
parameters, e.g., along the NorthSouth and EastWest directions. We wish to
nd the lowest valley in this terrain. SA approaches this problem similar to using a
bouncing ball that can bounce over mountains from valley to valley. We start at a
high temperature, where the temperature is an SA parameter that mimics the
effect of a fast moving particle in a hot object like a hot molten metal, thereby
permitting the ball to make very high bounces and being able to bounce over any
mountain to access any valley, giv en enough bounces. As the temperature is made
relatively colder, the ball cannot bounce so high, and it also can settle to become
trapped in relatively smaller ranges of valleys.
We imagine that our mountain range is aptly described by a cost function. We
dene probability distributions of the two directional parameters, called generating
distributions since they generate possible valleys or states we are to explore. We
dene another distribution, called the acceptance distribution, which depends on
the difference of cost functions of the present generated valley we are to explore
and the last saved lowest valley. The acceptance distribution decides
probabilistically whether to stay in a new lower valley or to bounce out of it. All
the generating and acceptance distributions depend on temperatures.
SMFM Lester Ingber
Outline of ASA Algorithm
For parameters

i
k
[ A
i
, B
i
] ,
sampling with the random variable x
i
,
x
i
[1, 1] ,

i
k+1

i
k
+ x
i
(B
i
A
i
) ,
dene the generating function
g
T
(x)
D
i1

1
2 ln(1 + 1/T
i
)(| x
i
| + T
i
)

D
i1

g
i
T
(x
i
) ,
in terms of parameter temperatures
T
i
T
i0
exp(c
i
k
1/D
) .
The cost-functions L under consideration are of the form
h(M; ) exp(L/T) ,
L Lt +
1
2
ln(2 tg
2
t
) ,
where L is a Lagrangian with dynamic variables M(t), and parameter-coefcients
to be t to data. g
t
is the determinant of the metric, and T is the cost
temperature.
SMFM Lester Ingber
Index of Pre-Compile Tuning Parameters
OPTIONS_FILE
OPTIONS_FILE_DAT A
RECUR_OPTIONS_FILE
RECUR_OPTIONS_FILE_DAT A
COST_FILE
ASA_LIB
HAVE_ANSI
IO_PROT OTYPES
TIME_CALC
TIME_STD
TIME_GETRUSAGE
INT_LONG
INT_ALLOC
SMALL_FLOAT
MIN_DOUBLE
MAX_DOUBLE
EPS_DOUBLE
CHECK_EXPONENT
NO_PARAM_TEMP_TEST
NO_COST_TEMP_TEST
SELF_OPTIMIZE
ASA_TEST
ASA_TEST_POINT
MY_TEMPLATE
USER_INITIAL_COST_TEMP
RATIO_TEMPERATURE_SCALES
USER_INITIAL_PARAMETERS_TEMPS
DELTA_PARAMETERS
QUENCH_PARAMETERS
QUENCH_COST
QUENCH_PARAMETERS_SCALE
QUENCH_COST_SCALE
ASA_TEMPLATE
OPTIONAL_DAT A
OPTIONAL_DAT A_INT
USER_COST_SCHEDULE
USER_ACCEPT_ASYMP_EXP
USER_ACCEPTANCE_TEST
USER_GENERATING_FUNCTION
USER_REANNEAL_COST
USER_REANNEAL_PARAMETERS
MAXIMUM_REANNEAL_INDEX
REANNEAL_SCALE
ASA_SAMPLE
ASA_QUEUE
ASA_RESOLUTION
FITLOC
FITLOC_ROUND
FITLOC_PRINT
MULTI_MIN
MULTI_NUMBER
ASA_PARALLEL
ASA_SAVE
SYSTEM_CALL
FDLIBM_POW
FDLIBM_LOG
FDLIBM_EXP
ASA_PRINT
ASA_OUT
USER_ASA_OUT
ASA_PRINT_INTERMED
ASA_PRINT_MORE
G_FIELD & G_PRECISION
SMFM Lester Ingber
Index of Adaptive Tuning Parameters
OPTIONS->Limit_Acceptances
OPTIONS->Limit_Generated
OPTIONS->Limit_Invalid_Generated_States
OPTIONS->Accepted_To_Generated_Ratio
OPTIONS->Cost_Precision
OPTIONS->Maximum_Cost_Repeat
OPTIONS->Number_Cost_Samples
OPTIONS->Temperature_Ratio_Scale
OPTIONS->Cost_Parameter_Scale_Ratio
OPTIONS->Temperature_Anneal_Scale
OPTIONS->User_Cost_Temperature
OPTIONS->Include_Integer_Parameters
OPTIONS->User_Initial_Parameters
OPTIONS->Sequential_Parameters
OPTIONS->Initial_Parameter_Temperature
OPTIONS->User_Temperature_Ratio
OPTIONS->User_Parameter_Temperature
OPTIONS->Acceptance_Frequency_Modulus
OPTIONS->Generated_Frequency_Modulus
OPTIONS->Reanneal_Cost
OPTIONS->Reanneal_Parameters
OPTIONS->Delta_X
OPTIONS->User_Delta_Parameter
OPTIONS->User_Tangents
OPTIONS->Curvature_0
OPTIONS->User_Quench_Param_Scale
OPTIONS->User_Quench_Cost_Scale
OPTIONS->N_Accepted
OPTIONS->N_Generated
OPTIONS->Locate_Cost
OPTIONS->Immediate_Exit
OPTIONS->Best_Cost
OPTIONS->Best_Parameters
OPTIONS->Last_Cost
OPTIONS->Last_Parameters
OPTIONS->Asa_Data_Dim
OPTIONS->Asa_Data
OPTIONS->Asa_Data_Dim_Int
OPTIONS->Asa_Data_Int
OPTIONS->Asa_Out_File
OPTIONS->Cost_Schedule
OPTIONS->Asymp_Exp_Param
OPTIONS->Acceptance_Test
OPTIONS->User_Acceptance_Flag
OPTIONS->Cost_Acceptance_Flag
OPTIONS->Cost_Temp_Curr
OPTIONS->Cost_Temp_Init
OPTIONS->Cost_Temp_Scale
OPTIONS->Prob_Bias
OPTIONS->Random_Seed
OPTIONS->Generating_Distrib
OPTIONS->Reanneal_Cost_Function
OPTIONS->Reanneal_Params_Function
OPTIONS->Bias_Acceptance
OPTIONS->Bias_Generated
OPTIONS->Average_Weights
OPTIONS->Limit_Weights
OPTIONS->Queue_Size
OPTIONS->Queue_Resolution
OPTIONS->Coarse_Resolution
OPTIONS->Fit_Local
OPTIONS->Iter_Max
OPTIONS->Penalty
OPTIONS->Multi_Cost
OPTIONS->Multi_Params
OPTIONS->Multi_Grid
OPTIONS->Multi_Specify
OPTIONS->Gener_Mov_Avr
OPTIONS->Gener_Block
OPTIONS->Gener_Block_Max
SMFM Lester Ingber
Reannealing Example
1 100 10000 1000000
generated
10
-10
10
0
10
10
10
20
c
o
s
t
ASA D=8
No Reanneal
Superimposed are runs for n 8, the case of no reannealing, 3 trajectories each for
cases of Q = 1, 2, 3, 4, 5, 6, 7, 8, 16, and 24. Although the actual nal cost
function values are 0, they were set to 10
10
for purposes of these log-log plots.
1 10 100 1000 10000 100000
generated
10
-10
10
0
10
10
10
20
c
o
s
t
ASA D=8

Superimposed are runs for n 8, the case including reannealing, 3 trajectories each
for cases of Q = 1, 2, 3, 4, 5, 6, 7, 8, 16, and 24.
SMFM Lester Ingber
Example: Fitting Variance
Consider a one variable problem,
P[M
t+t
| M
t
] (2 g
2
t)
1/2
exp(tL) ,
L (

M f )
2
/(2 g
2
) ,
with parameter-coefcients n f and g to be t to data.
The cost function to be t to M(t) data is
L Lt +
1
2
ln(2 tg
2
t
) ,
The nonlinear entry of g into the cost function, e.g., competing inuence in the
denominator of L and in the logarithm term from the prefactor in P, often enables
a tight t to the absolute value of g. In most nonlinear regression methods, this is
not possible.
Similar considerations hold for more than one variable. The calculation of the
ev olution of Langevin systems has been implemented in several systems using
ASA. It has been used as an aid to debug the ASA tting codes, by rst generating
data from coupled Langevin equations, relaxing the coefcients, and then tting
this data with the effective Lagrangian cost-function algorithm to recapture the
original coefcients within the diffusions dened by g
GG
.
SMFM Lester Ingber
Numerical Path Integration (PATHINT)
Given a form for L, we use the path-integral to calculate the long-time distribution
of variables. This is impossible in general to calculate in closed form, and we
therefore must use numerical methods. PATHINT is a code developed for
calculating highly nonlinear multivariate Lagrangians.
The path-integral calculation of the long-time distribution, in addition to being a
predictor of upcoming information, provides an internal check that the system can
be well represented as a nonlinear Gaussian-Markovian system. The use of the
path integral to compare different models is akin to comparing short- and long-time
correlations. Complex boundary conditions can be cleanly incorporated into this
representation, using a variant of boundary element techniques.
SMFM Lester Ingber
Outline of PATHINT Algorithm
The histogram procedure recognizes that the distribution can be numerically
approximated to a high degree of accuracy as sum of rectangles at points M
i
of
height P
i
and width M
i
. For convenience, just consider a one-dimensional
system. The above path-integral representation can be rewritten, for each of its
intermediate integrals, as
P(M; t + t)

dM[g
1/2
s
(2 t)
1/2
exp(L
s
t)]P(M; t)

dMG(M, M; t)P(M; t) ,
P(M; t)
N
i1

(M M
i
)P
i
(t) ,
(M M
i
)

1 , (M
i

1
2
M
i1
) M (M
i
+
1
2
M
i
) ,
0 , otherwise ,
which yields
P
i
(t + t) T
ij
(t)P
j
(t) ,
T
ij
(t)
2
M
i1
+ M
i

M
i
+M
i
/2
M
i
M
i1
/2
dM

M
j
+M
j
/2
M
j
M
j1
/2
dMG(M, M; t) .
SMFM Lester Ingber
Boundary Condition Sensitivity
For derivative boundary conditions, for better numerical accuracy, it often is
necessary to generalize the histogram expansion to a trapezoidal expansion to give
some shape to the histograms.
SMFM Lester Ingber
Mesh Limitations
Care must be used in developing the mesh in M
G
, which is strongly dependent on
the diagonal elements of the diffusion matrix, e.g.,
M
G
(tg
|G||G|
)
1/2
.
Presently, this constrains the dependence of the covariance of each variable to be a
nonlinear function of that variable, albeit arbitrarily nonlinear, in order to present a
straightforward rectangular underlying mesh.
A previous paper attempted to circumvent this restriction by taking advantage of
Riemannian transformations to a relatively diagonal problem.
For more than one variable, the above constraints on the mesh only sufce for
diagonal elements of the g
GG
matrix. To consider the inuence on off-diagonal
terms, a tiling approach should be taken to the full mesh.
SMFM Lester Ingber
SOME FINANCIAL APPLICATIONS
SMFM Lester Ingber
Risk-Averting Agents
Some insight may be gained into how a market becomes reasonably described by a
parabolic PDE, by performing a simple statistical mechanics of risk-averting
agents.
Consider the conditional probability distribution, p
j
, of an agent j operating on a
given market. For simplicity, assume that at time t + , j must decide whether to
buy or sell a standard increment of the market, based only on the information of the
total number of buyers, M
B
, and sellers, M
S
, at time t. For example, take
p

j

exp(
j
F
j
)
[exp(F
j
) + exp(F
j
)]

1
2
[1 erf(
j
F
j
/2)] ,

+1
1
buy ( j B) or sell ( j S)
do not act ,
p
+
+ p

1 ,
F
j
F
j
(M
G
) ,
G B, S .
F
j
may be any reasonably well-behaved function of M
B
and M
S
, different for
buyers, F
j B
F
B
, or sellers, F
j S
F
S
. F
j
is considered to represent a
decision factor representing a typical rational agent in the market.
A simple example of F
j
for agents following market trends is obtained from
F
G
ex1
a
G
M

/N ,
M

M
B
M
S
,
where a
G
are constants, a
B
< 0 and a
S
> 0, for agents following the trends of the
market. I.e., agent j acts according to a sigmoid distribution with respect to market
trends: p

j
is concave with respect to gains, and convex with respect to losses.
Assume that the total numbers of potential buyers and sellers are each constants,
j
S
1,
. . .
, N
S
,
j
B
1,
. . .
, N
B
,
N N
B
+ N
S
.
SMFM Lester Ingber
Aggregation of Risk-Averting Agents
At any giv en time, any agent may belong to either pool of S or B. If each agent is
considering one unit of a markets assets, then the following development becomes
a microscopic model of the dynamics of the markets volume. The joint
probability distribution P, joint with respect to pools of all S and B agents, but
conditional with respect to time evolution, is
P[M(t + )| M(t)]
B,S
G

P
G
[M
G
(t + )| M
G
(t)]

j
1

(
j S

j
N
S
) (
j B

j
N
B
)
N
j

(2 )
1

dQ
G
exp[iM
G
(t + )Q
G
]

N
G
j G

cosh F
j
[M(t)] + iQ
G
sechF
j
[M(t)]

(1 + E
G
)
N
G
j
(
N
G

G
\
,
(E
G
)

G
,
E
G
exp(2F
G
) ,

G
[[
1
2
(M
G
(t + ) + N
G
)]] ,
M M
G
,
where M
G
(t) represents contributions from both G S and G B at time t, and

G
is dened as the greatest integer in the double brackets. For convenience only,

j
F
j
was dened so that M
G
0 is arbitrarily selected as a midpoint between
agents acting and not acting on the market: M
G
N
G
signies all agents not
acting, M
G
N
G
signies all agents acting.
The mean and variance of this binomial distribution yields
< M
G
(t + ) > N
G
tanh F
G
,
< M
G
(t + )M
G
(t + ) > < M
G
(t + ) >< M
G
(t + ) >
1
4

G
G
N
G
sech
2
F
G
.
For large N
G
and large N
G
F
G
, this binomial distribution is asymptotically
Gaussian. yielding a parabolic PDE.
SMFM Lester Ingber
Interest Rates
SMFM Lester Ingber
2-Factor Interest-Rate Model
The Brennan-Schwartz (BS) model is developed in the variables of short- and long-
term interest rates, assumed to follow a joint Wiener stochastic process,
dr
1
(r, l, t)dt +
1
(r, l, t)dz
1
,
dl
2
(r, l, t)dt +
2
(r, l, t)dz
2
,
where r and l are the short- and long-term rates, respectively.
1
and
2
are the
expected instantaneous rates of change in the short-term and long-term rates
respectively.
1
and
2
are the instantaneous standard deviations of the processes.
dz
1
and dz
2
are Wiener processes, with expected values of zero and variance of dt
with correlation coefcient . BS simplied and reduced this system to
dr ((a
1
+ b
1
(l r)))dt + r
1
dz
1
,
dl l(a
2
+ b
2
r + c
2
l)dt + l
2
dz
2
,
where a
1
, b
1
, a
2
, b
2
, c
2
are parameters to be estimated.
SMFM Lester Ingber
Lagrangian Representation
The BS equations can be rewritten as Langevin equations (in the Ito prepoint
discretization)
dr/dt a
1
+ b
1
(l r) +
1
r(
+
n
1
+

n
2
) ,
dl/dt l(a
2
+ b
2
r + c
2
l) +
2
l(

n
1
+
+
n
2
) ,

1
2
[1 (1
2
)
1/2
]
1/2
,
n
i
(dt)
1/2
p
i
,
where p
1
and p
2
are independent [0,1] Gaussian distributions.
L
1
2
F

gF ,
F
j
(
dr/dt ((a
1
+ b
1
(l r)))
dl/dt l(a
2
+ b
2
r + c
2
l)
\
,
,
g det(g) ,
k 1
2
.
g, the metric in r, l-space, is the inverse of the covariance matrix,
g
1

j
(
(r
1
)
2
rl
1

2
rl
1

2
(l
2
)
2
\
,
.
The cost function C is dened from the equivalent short-time probability
distribution, P, for the above set of equations.
P g
1/2
(2 dt)
1/2
exp(Ldt)
exp(C) ,
C Ldt +
1
2
ln(2 dt) ln(g) .
SMFM Lester Ingber
ASA Fits
Interest rates were developed from Treasury bill and bond yields during the period
October 1974 through December 1979, the same period as one of the sets used by
BS. Short-term rates were determined from Treasury bills with a maturity of three
months (BS used 30-day maturities), and long-term rates were determined from
Treasury bonds with a maturity of twenty years (BS used at least 15-year
maturities).
For daily data, the actual number of days between successive trades was used; i.e.,
during this time period we had 1282 pieces of daily data and 62 pieces of end-of-
month data. Then we did all subsequent runs using the scale of one day. We used
yearly rates divided by 365 to t the parameters.
The BS parameters also were run through the data, calculating the cost function
they giv e. The single cost function bears the weight of determining all parameters.
Note that we have used data not quite the same as they used; we used the same
time period, but a different set of bonds to determine interest rates. This likely can
account for some of the apparent drastic improvements of our ts over theirs. Also
note that the negative C we calculate is obtained from the negative ln term which
has a very small argument. E.g., in the nal column, C 23. 83 is obtained by
adding an average (over all data points) ln contribution of 24. 80 to a positive
av erage L. Competition between the diminishing positive numerators in L and
the diminishing diffusions in the ln term and in the denominators of L accounts for
the nal value of C. It should be noted that for all periods before October 1974,
back through December 1958, using monthly data, BS found a
1
< 0, and for the
period April 1964 through June 1969 they found c
2
> 0.
SMFM Lester Ingber
Bond PDE/PATHINT
Some tentative PATHINT calculations were performed by another researcher. It
would be interesting to repeat them.
Using methods of stochastic calculus, BS further derived a partial differential
equation for bond prices as the maturity date is approached.

B ((r + f
r

r
+ f
l

l
+ g
rr

r
2
+ g
rl

rl
+ g
ll

l
2
))B
AB ,
where the coefcients f , g depend on r and l, = T t for t calendar time and T
the time of maturity, and A can be considered as a differential operator on B.
It may help to appreciate the importance of the BS methodology by discretizing the
above partial differential equation for B, in a mean-value limit. That is, at a
given calendar time t indexed by s, noting that / = /t, take
0 f
r
B
s
r
f
l
B
s
l
,
0 g
rr
B
s
r
2
g
rl
B
s
rl
g
ll
B
s
l
2
,
B
s
B
s+1
r
s
B
s
.
This yields the popular expectations-hypothesis spot-interest estimate of bond
prices, working backwards from maturity,
B
s
(1 + r
s
)
1
B
s+1
.
The important generalization afforded by BS is to include information about r and
l and treat them as stochastic variables with drifts and diffusions. Then, this
discretized treatment yields
B
s rl
(1 A
s rlrl
)
1
B
s+1 rl
,
where the operator inverse of the differential operator A has been formally written,
and its dependence on intermediate values of r and l has been explicitly
portrayed. Their discretized calculation of their partial differential equation, and
our discretized calculation of the path-integral representation of this model, are
different numerical methods of calculating this evolution of B
s
.
SMFM Lester Ingber
S&P
SMFM Lester Ingber
S&P Interday Futures-Cash
Too often the management of complex systems is ill-served by not utilizing the
best tools available. For example, requirements set by decision-makers often are
not formulated in the same language as constructs formulated by powerful
mathematical formalisms, and so the products of analyses are not properly or
maximally utilized, even if and when they come close to faithfully representing the
powerful intuitions they are supposed to model. In turn, even powerful
mathematical constructs are ill-served, especially when dealing with multivariate
nonlinear complex systems, when these formalisms are butchered into quasi-linear
approximations to satisfy constraints of numerical algorithms familiar to particular
analysts, but which tend to destroy the power of the intuitive constructs developed
by decision-makers. These problems are present in many disciplines, including
trading in nancial markets. In this context, we can consider the trader as the
decision maker on the nature of market data, sometimes also carrying the
additional role of his or her own analyst.
CMI and ASA were blended together to form a simple trading code, TRD. An
example was published on inter-day trading the S&P 500, using stops for losses on
short and long trades and using CMI of the coupled cash and futures data. Data for
years 1989 and 1990 was used, wherein one of the years was used to train TRD,
and the other year to test TRD; then the years were reversed to establish two
examples of trading on two years of quite different data.
In the 1991 study, it was noted that the sensitivity of testing trades to CMI
overshadowed any sensitivity to the stops. Therefore, a second study was
performed on this same data, but using only CMI. Better results were obtained, but
more important, this established that the CMI themselves could lead to protable
trading, taking advantage of inefciencies in these markets. Therefore, CMI at
least can be useful supplemental indicators for other trading systems.
SMFM Lester Ingber
Inner-Shell Dynamic Model
The model contains an inner-shell and an outer-shell, both of which need to be
optimally t to data. The inner shell develops CMI as trading indicators. Many
traders use such indicators as price, volume, etc., to trade, but here we explored the
use of CMI to see if a true quantitative measure of momenta could be used. This
required that the CMI be t to data, e.g., to dene quantities that themselves are
functions of price. The cost function for the CMI is directly related to the
Lagrangian. For the S&P studies, a two-variable model was used of end-of-day
cash and futures, c(r) and f (r), for day r, taking the variables to be ratios between
days, e.g.,
C(r)
c(r)
c(r 1)
,
F(r)
f (r)
f (r 1)
.
These ratio-variables were used to develop coupled SDEs,

C f
C
C
C + f
F
C
F + g
C
1

1
+ g
C
2

F f
C
F
C + f
F
F
F + g
F
1

1
+ g
F
2

2
where all eight f and g parameters were taken to be constants, and the two s
were independent sources of Gaussian-Markovian noise. This set of SDEs were
recast into a Lagrangian representation to dene a single cost function, whose
parameters were t by ASA to data.
SMFM Lester Ingber
Outer-Shell Trading Model
The outer shell is the set of trading rules, dened as moving averages of the
momenta indicators over various sized windows. This is pretty much like many
simple trading rules, but here ASA is used to nd the optimal sizes of the windows
and of the thresholds triggering trading actions. Here, the thresholds are in terms
of the CMI.
The CMI are t to a years worth of data, but they are continually ne-tuned within
the widest moving window used in the outer shell. The cost function for the
trading rules is the net prot over a year of data. Over the course of a year, every
day a trading decision is made on the CMI, but only after the CMI are tuned using
optimization over the widest window. This denes the need for recursive
optimization.
SMFM Lester Ingber
Recursive ASA Fits
A simple outer-shell AI-type model for trading was dened for the TRD code. A
wide and a narrow window were dened, whose widths were parameters of TRD.
These windows dened epochs over which moving averages of CMI were
calculated for both the C and F variables. For each window, a short and a long
threshold parameter were dened. If the CMI of both C and F were above the
thresholds in both the wide and narrow windows, then a long trade was executed or
maintained for the futures market. Similarly, if the CMI of C and F fell below the
negative of these threshold parameters in the two windows, a short trade was
executed or maintained. Otherwise, no trade was executed.
Thus, the six parameters of the outer-shell were the widths of the two windows and
the two threshold parameters for each of the two variables. Each day, the CMI
were determined by an inner-shell optimization: Over the length of the wide
window, using the zeroth-order prior t as a rst guess, two of the CMI parameters
were ret to the data in the window. At rst, ASA was used recursively to
establish the best t, but it was determined for this system that only small
perturbations of the CMI were regularly required, and so thereafter a faster quasi-
local code was used.
Stepping through the trading decisions each trading day of a years data determined
the yearly net prot/loss as the single value of the outer-shell cost function. ASA
then importance-sampled the CMI parameter space to determine the largest net
prot, determining the nal CMI parameters in the training set.
The CMI parameter values in TRD were then used to trade for an out-of-sample
year of data. The inner-shell optimization was performed each day as before.
SMFM Lester Ingber
SOME OUT-OF-FINANCE LESSONS LEARNED
SMFM Lester Ingber
Statistical Mechanics of Combat (SMC)
SMFM Lester Ingber
National Training Center Janus(T)
The U.S. Army National Training Center (NTC) is located at Fort Irwin, just
outside Barstow, California. As of 1989, there have been about 1/4 million soldiers
in 80 brigade rotations at NTC, at the level of two battalion task forces (typically
about 3500 soldiers and a battalion of 15 attack helicopters), which train against
two opposing force (OPFOR) battalions resident at NTC. NTC comprises about
2500 km
2
, but the current battleeld scenarios range over about 5 km linear spread,
with a maximum lethality range of about 3 km. NTC is gearing up for full brigade
level exercises. The primary purpose of data collection during an NTC mission is
to patch together an after action review (AAR) within a few hours after completion
of a mission, giving feedback to a commander who typically must lead another
mission soon afterward. Data from the eld, i.e., multiple integrated laser
engagement system (MILES) devices, audio communications, OCs, and stationary
and mobile video cameras, is sent via relay stations back to a central command
center where this all can be recorded, correlated and abstracted for the AAR.
Within a couple of weeks afterwards, a written review is sent to commanders, as
part of their NTC take home package.
Janus(T) is an interactive, two-sided, closed, stochastic, ground combat computer
simulation. We hav e expanded Janus(T) to include air and naval combat, in several
projects with the authors previous thesis students at the Naval Postgraduate School
(NPS).
Stochastic multivariate models were developed for both NTC and Janus, to form a
common language to compare the two systems to baseline the simulation to
exercise data.
SMFM Lester Ingber
Basic Equations of Aggregated Units
Consider a scenario taken from our NTC study: two red systems, red T-72 tanks
(RT) and red armored personnel carriers (RBMP), and three blue systems, blue
M1A1 and M60 tanks (BT), blue armored personnel carriers (BAPC), and blue
tube-launched optically-tracked wire-guided missiles (BTOW), where RT species
the number of red tanks at a given time t, etc. Consider the kills suffered by BT,
BT, e.g., within a time epoch t 5 min. Here, the x terms represent attrition
owing to point re; the y terms represent attrition owing to area re. Note that the
algebraic forms chosen are consistent with current perceptions of aggregated large
scale combat. Now consider sources of noise, e.g., that at least arise from PD, PA,
PH, PK, etc. Furthermore, such noise likely has its own functional dependencies,
e.g., possibly being proportional to the numbers of units involved in the combat.
We write

BT
BT
t
x
BT
RT
RT + y
BT
RT
RT BT + x
BT
RBMP
RBMP + y
BT
RBMP
RBMP BT
+z
BT
BT
BT
BT
BT
+ z
BT
RT

BT
RT
+ z
BT
RBMP

BT
RBMP

RT
. . .

RBMP
. . .

BAPC
. . .

BTOW
. . .
where the represent sources of (white) noise (in the Ito prepoint discretization
discussed below). The noise terms are taken to be log normal (multiplicative)
noise for the diagonal terms and additive noise for the off-diagonal terms. The
diagonal z term (z
BT
BT
) represents uncertainty associated with the target BT, and the
off-diagonal z terms represent uncertainty associated with the shooters RT and
RBMP. The x and y are constrained such that each term is bounded by the mean
of the KVS, averaged over all time and trajectories of similar scenarios; similarly,
each z term is constrained to be bounded by the variance of the KVS. Equations
similar to the

BT equation are also written for

RT,

RBMP,

BAPC, and

BTOW.
Only x and y that reect possible nonzero entries in the KVS are free to be used
for the tting procedure. For example, since Janus(T) does not permit direct-re
fratricide, such terms are set to zero. In most NTC scenarios, fratricide typically is
negligible.
SMFM Lester Ingber
Long-Time Correlations Test Short-Time Models
Especially because we are trying to mathematically model sparse and poor data,
different drift and diffusion algebraic functions can give approximately the same
algebraic cost-function when tting short-time probability distributions to data.
The calculation of long-time distributions permits a better choice of the best
algebraic functions, i.e., those which best follow the data through a predetermined
epoch of battle. Thus, dynamic physical mechanisms, beyond simple Lanchester
line and area ring terms, can be identied. Afterwards, if there are closely
competitive algebraic functions, they can be more precisely assessed by calculating
higher algebraic correlation functions from the probability distribution.
Data from 35 to 70 minutes was used for the short-time t. The path integral used
to calculate this tted distribution from 35 minutes to beyond 70 minutes. This
serves to compare long-time correlations in the mathematical model versus the
data, and to help judge extrapolation past the data used for the short-time ts. The
means are t very well by this model, even in out-of-sample time periods,
something that other Lanchester modelers have not achieved, especially with such
empirical data. The variances strongly suggest that the additive-noise model is
inferior.
SMFM Lester Ingber
CMI
The results of Janus(T) attrition of Red and Blue units are given in the upper gure.
The canonical momenta indicators (CMI) for each system are given in the lower
gure.
30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0 70.0
time (min)
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
100.0
u
n
i
t
s
Combat Units
RT
RBMP
BT
BAPC
BTOW
30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0 70.0
time (min)
-100.0
-80.0
-60.0
-40.0
-20.0
0.0
20.0
40.0
m
o
m
e
n
t
a
Combat Canonical Momenta
RT
RBMP
BT
BAPC
BTOW
Using the particular model considered here, the CMI are seen to be complementary
to the attrition rates, being somewhat more sensitive to changes in the battle than
the raw data. The coefcients t to the combat data are modiable to t the current
reality of system capabilities.
The CMI are more sensitive measures than the energy density, effectively the
square of the CMI, or the information which also effectively is in terms of the
square of the CMI (essentially integrals over quantities proportional to the energy
times a factor of an exponential including the energy as an argument). This is even
more important when replenishment of forces is permitted, often leading to
oscillatory variables. Neither the energy or the information give details of the
components as do the CMI.
SMFM Lester Ingber
Statistical Mechanics of Neocortical Interactions (SMNI)
SMFM Lester Ingber
Basic SMNI
SMFM Lester Ingber
Multiple Scales
Multiple scales are aggregated, from synaptic dynamics, to neuronal dynamics, to
minicolumnar dynamics (100s of neurons). At the level of minicolumns,
neocortex seems to be well described by Gaussian-Markovian dynamics.
A derivation is given of the physics of chemical inter-neuronal and electrical intra-
neuronal interactions. The derivation yields a short-time probability distribution of
a giv en neuron ring due to its just-previous interactions with other neurons.
Within
j
510 msec, the conditional probability that neuron j res (
j
+1) or
does not re (
j
1), given its previous interactions with k neurons, is
p

j

exp(
j
F
j
)
exp(F
j
) + exp(F
j
)
,
F
j

V
j

k

jk
v
jk
((
k

jk
(v
jk
2
+
jk
2
)))
1/2
,
a
jk

1
2
A
jk
(
k
+ 1) + B
jk
.
represents the intra-neuronal probability distribution.
SMFM Lester Ingber
Microscopic Aggregation
A derived mesoscopic Lagrangian L
M
denes the short-time probability
distribution of rings in a minicolumn, composed of 10
2
neurons, given its just
previous interactions with all other neurons in its macrocolumnar surround. G is
used to represent excitatory (E) and inhibitory (I ) contributions. G designates
contributions from both E and I .
P
M

G

P
G
M
[M
G
(r; t + )| M
G
(r; t)]

j
(
jE

j
M
E
(r; t + )
\
,

j
(
jI

j
M
I
(r; t + )
\
,
N
j

(2 g
GG
)
1/2
exp(N L
G
M
) ,
P
M
(2 )
1/2
g
1/2
exp(N L
M
) ,
L
M
L
E
M
+ L
I
M
(2N)
1
(

M
G
g
G
)g
GG
(

M
G
g
G
) + M
G
J
G
/(2N ) V ,
V
G

V
G
G
(M
G
)
2
,
g
G

1
(M
G
+ N
G
tanh F
G
) ,
g
GG
(g
GG
)
1

G
G

1
N
G
sech
2
F
G
,
g det(g
GG
) ,
F
G

(V
G
a
|G|
G
v
|G|
G
N
G

1
2
A
|G|
G
v
|G|
G
M
G
)
(( [(v
|G|
G
)
2
+ (
|G|
G
)
2
](a
|G|
G
N
G
+
1
2
A
|G|
G
M
G
)))
1/2
,
a
G
G

1
2
A
G
G
+ B
G
G
.
SMFM Lester Ingber
Short-Term Memory (STM)
We choose empirical ranges of synaptic parameters corresponding to a
predominately excitatory case (EC), predominately inhibitory case (IC), and a
balanced case (BC) in between. For each case, also consider a centering
mechanism (EC, IC, BC), whereby some synaptic parameter is internally
manipulated, e.g., some chemical neuromodulation or imposition of patterns of
ring, such that there is a maximal efciency of matching of afferent and efferent
rings:
M
G
M
G
0 .
This sets conditions on other possible minima of the static Lagrangian L.
SMFM Lester Ingber
PDE Stability & Duration Analyses
An estimate of a stationary solution P
stat
to the Fokker-Planck differential equation
for the probability distribution P of M
G
rings for an uncoupled mesocolumn, i.e.,
V 0, is given by the stationary limit of the short-time propagator,
P
stat
N
stat
g
1/2
exp(CN Lbar) ,
g det(g
GG
)
1
det(g
GG
) g
EE
g
II
,
where N
stat
and C are constant factors. An estimate of the approximation made is
made by seeking values of constants C, such that the stationary Fokker-Planck
equation is satised exactly. Contour plots of C versus M
G
demonstrate that there
exists real positive C which may only range from 10
1
to 1, for which there
exists unbroken contours of C which pass through or at least border the line of
minima. At each point M
G
, this leaves a quadratic equation for C to be solved.
Dropping the g
1/2
factor results in C not being real throughout the domain of M
G
.
Thus, this denes a solution with potential N
2
L

AdM, drift A, and diffusion

N/ . Stability of transient solutions, dened for M
G
about a stationary state by

M
G
A
,G
M
G
N
2
L
,GG
M
G
, is therefore equivalent to << M >> being
minima of L. This stationary solution is also useful for calculating the time of rst
passage, t
vp
, to uctuate out of a valley in one minima over a peak to another
minima. It turns out that the values of L10
2
for which the minima exist are just
right to give t
vp
on the order of tenths a second for about 9 of the minima when the
maximum of 1011 are present. The other minima give t
vp
on the order of many
seconds, which is large enough to cause hysteresis to dominate single jumps
between other minima. Thus, 7 2 is the capacity of STM, for memories or new
patterns which can be accessed in any order during tenths of a second, all as
observed empirically.
This is a very sensitive calculation. If N were a factor of 10 larger, or if L < 0. 1
at the minima, then t
vp
is on the order of hours instead of seconds, becoming
unrealistic for STM durations. Oppositely, if t
vp
were much smaller, i.e., less than
5 , this would be inconsistent with empirical time scales necessary for formation
of any memory trace.
The statistical nature of this storage and processing also explains the primacy vs.
recency effect in STM serial processing, wherein rst-learned items are recalled
most error-free, with last-learned items still more error-free than those in the
middle.
SMFM Lester Ingber
STM PATHINT Details
The interior of M
G
-space of model BC is examined at 0.01 seconds = .
PATHINT STM BC t=1
BCP_001
0.0382
0.0306
0.0229
0.0153
0.00764
-50
0
50
-30
-20
-10
0
10
20
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
0.04
0.045
0.05
E
I
P
SMFM Lester Ingber
Electroencephalography (EEG)
A coarse calculation begins by considering the Lagrangian L
F
, the Feynman
midpoint-discretized Lagrangian. The Euler-Lagrange variational equation
associated with L
F
leads to a set of 12 coupled rst-order differential equations,
with coefcients nonlinear in M
G
, in the 12 variables
M
G
,

M
G
,

M
G
, M
G
,
2
M
G
in (r; t) space. In the neighborhood of extrema
<< M
G
>>, L
F
can be expanded as a Ginzburg-Landau polynomial, i.e., in powers
of M
E
and M
I
. To inv estigate rst-order linear oscillatory states, only powers up
to 2 in each variable are kept, and from this the variational principle leads to a
relatively simple set of coupled linear differential equations with constant
coefcients:
0 L
F
L
F,

G:t

G
L
F
f
|G|

M
|G|
+ f
1
G

M
G

g
|G|

2
M
|G|
+ b
|G|
M
|G|
+ b M
G

, G

G ,
(
. . .
)
,

G:t
(
. . .
)
,

GG

M
G
+ (
. . .
)
,

M
G
,
M
G
M
G
<< M
G
>> , f
1
E
f
1
I
f .
These equations are then Fourier transformed and the resulting dispersion relation
is examined to determine for which values of the synaptic parameters and of the
normalized wav e-number , the conjugate variable to r, can oscillatory states,
(), persist.
For instance, a typical example is specied by extrinsic sources J
E
2. 63 and
J
I
4. 94, N
E
125, N
I
25, V
G
10 mV, A
G
E
1. 75, A
G
I
1. 25, B
G
G
0. 25,
and v
G
G

G
G
0. 1 mV. The synaptic parameters are within observed ranges, and
the J
G
s are just those values required to solve the Euler-Lagrange equations at the
selected values of M
G
. The global minimum is at M
E
25 and M
I
5. This set
of conditions yields (dispersive) dispersion relations
1. 86 + 2. 38( )
2
; 1. 25i + 1. 51i( )
2
,
where ||. The propagation velocity dened by d/d is 1 cm/sec, taking
typical wav enumbers to correspond to macrocolumnar distances 30.
Calculated frequencies are on the order of EEG frequencies 10
2
sec
1
,
equivalent to /(2 )= 16 cps (Hz). These mesoscopic propagation velocities
permit processing over sev eral minicolumns 10
1
cm, simultaneous with the
processing of mesoscopic interactions over tens of centimeters via association
bers with propagation velocities 600900 cm/sec. I.e., both intraregional and
interregional information processing can occur within 10
1
sec.
SMFM Lester Ingber
ASA Fits of CMI
These momenta indicators should be considered as supplemental to other clinical
indicators. This is how they are being used in nancial trading systems. The CMI
are more sensitive measures of neocortical activity than other invariants such as the
energy density, effectively the square of the CMI, or the information which also
effectively is in terms of the square of the CMI. Neither the energy or the
information give details of the components as do the CMI. EEG is measuring a
quite oscillatory system and the relative signs of such activity are quite important.
Each set of results is presented with 6 gures, labeled as [alcoholic|control,
stimulus 1|match|no-match, subject, potential|momenta], where match or no-
match was performed for stimulus 2 after 3.2 sec of a presentation of stimulus 1.
For each subjects run, after tting 28 parameters with ASA, epoch by epoch
av erages are developed of the raw data and of the multivariate SMNI canonical
momenta. There are ts and CMI calculations using data sets from 10 control and
10 alcoholic subjects for each of 3 paradigms.
0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50
time (sec)
-0.30
-0.25
-0.20
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
m
o
m
e
n
t
a

(
1
/
u
V
)
SMNI Canonical Momenta
F3
F4
P7
P8
T7
T8
0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50
time (sec)
-0.20
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
m
o
m
e
n
t
a

(
1
/
u
V
)
SMNI Canonical Momenta
F3
F4
P7
P8
T7
T8
SMFM Lester Ingber
Chaos in SMNI
SMFM Lester Ingber
Dufng Analog
Some aspects of EEG can be approximately cast as a model of chaos, the Dufng
oscillator.
x f (x, t) ,
f x
2
0
x + B cos t .
This can be recast as
x y ,
y f (x, t) ,
f y
2
0
x + B cos t .
Note that this is equivalent to a 3-dimensional autonomous set of equations, e.g.,
replacing cos t by cos z, dening z , and taking to be some constant.
We studied a model embedding this deterministic Dufng system in moderate
noise, e.g., as exists in such models as SMNI. Independent Gaussian-Markovian
(white) noise is added to both x and y,
j
i
, where the variables are represented by
i x, y and the noise terms are represented by j 1, 2,
x y + g
1
x

1
,
y f (x, t) + g
2
y

2
,
<
j
(t) >

0 ,
<
j
(t),
j
(t) >

jj
(t t) .
In this study, we take moderate noise and simply set g
j
i
1. 0
j
i
.
The equivalent short-time conditional probability distribution P, in terms of its
Lagrangian L, corresponding to these Langevin rate-equations is
P[x, y; t + t| x, y, t]
1
(2 t)( g
11
g
22
)
2
exp(Lt) ,
L
( x y)
2
2( g
11
)
2
+
( y f )
2
2( g
22
)
2
.
SMFM Lester Ingber
Noise Washes Out Chaos/PATHINT
No differences were seen in the stochastic system, comparing regions of Dufng
parameters that give rise to chaotic and non-chaotic solutions. More calculations
must be performed for longer durations to draw more denitive conclusions.
Path Integral Evolution of Non-Chaotic Stochastic Duffing Oscillator
t=15
0.00423
0.00339
0.00254
0.00169
0.000847
-25
-20
-15
-10
-5
0
5
10
15
20 -25
-20
-15
-10
-5
0
5
10
15
20
0
0.001
0.002
0.003
0.004
0.005
0.006
X ->
Y ->
P
Path Integral Evolution of Chaotic Stochastic Duffing Oscillator
t=15
0.00425
0.0034
0.00255
0.0017
0.00085
-25
-20
-15
-10
-5
0
5
10
15
20 -25
-20
-15
-10
-5
0
5
10
15
20
0
0.001
0.002
0.003
0.004
0.005
0.006
X ->
Y ->
P
SMFM Lester Ingber
SOME CURRENT PROJECTS
SMFM Lester Ingber
Volatility Modeling
SMFM Lester Ingber
Eurodollar Spreads
It should be clear that the correlations we observe are specic to the time scales
and the windows used for averaging out data. These scales and windows have been
selected because of their widespread use in actual trading. However, this may not
imply correlations at other times scales or windows. The basis-point volatility
(BPV) is derived from the observed sample data of daily differenced yields
(dt 1), e.g.,
BPV <
n
n 1
(dy < dy >)
2
>
1/2
for a sample size of n points of data. The BPV is calculated over a sample of daily
data, e.g., 20 days,
BPV < y > .
The BPV is a more natural measure of the movement of the yields and is used
more by traders than by theorists. We regularly draw comparisons in our
calculations between the BPV and the BS volatility, i.e., , to be sure that we are
not inducing some effects by the choice of one volatility over the other.
We rst take standard deviations of the volatilities of each contract, then take the
av erage over similar contracts, e.g., with the same number of days until expiration.
This establishes that there is a distribution of volatilities over similar contracts,
beyond the act of their aggregation.
Trading on the ratios of Front/Back contracts often presents less risk than trading
on the separate contracts. Let w(x, y) be a function of 2 random variables (say,
w x/y, like Front and Back contracts). For small perturbations,
w < w > +(x < x >)
w
x
+ (y < y >)
w
y
+
. . .
,
< w > w(< x > , < y >) +
. . .
,
Var(w
2
) < (w < w >)
2
>

j
(
w
x
\
,
2
Var(x
2
) +
j
(
w
y
\
,
2
Var(y
2
) + 2
w
x
w
y
Var(xy) ,
Var(((x/y)
2
)) 1/y
2
Var(x
2
) + x
2
/y
4
Var(y
2
) 2x/y
3
Var(xy) .
Thus, the standard deviation of the ratio is reduced by the correlation Var(xy)
between the two contracts.
SMFM Lester Ingber
Eurodollar Volatility of Historical Volatility
The top gure gives a comparison of Basis-Point Volatility (BPV), standard
deviation of BPV (SDBPV), and standard deviation of differenced BPV
(SDDBPV), for Front and Back contracts. The SDBPV illustrate that there exists a
distribution of volatilities about the mean volatility. The SDDBPV illustrate that
this distribution likely is a stochastic process with a constant diffusion.
The bottom gure gives a comparison of standard deviation of differenced Basis-
Point Volatility (SDDBPV) with and standard deviation of differenced Black-
Scholes Volatility (SDDBSV), for Front and Back contracts. The SDDBSV have
been scaled to the SDDBPV by multiplying them by the rounded average of the
yields, i.e., 6.0. Note that after scaling, they consistently lie close to each other.
Thus, both the BPV and BSV have volatilities that can be considered to be
stochastic processes with constant diffusion.
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
-160 -140 -120 -100 -80 -60 -40 -20 0
V
o
la
tility
Days to Expiration
Front BPV
Back BPV
Front SDBPV
Back SDBPV
Front SDDBPV
Back SDDBPV
0.0015
0.002
0.0025
0.003
0.0035
0.004
0.0045
0.005
0.0055
0.006
0.0065
-160 -140 -120 -100 -80 -60 -40 -20 0
S
ta
n
d
a
r
d
D
e
v
ia
tio
n
o
f D
iffe
r
e
n
c
e
d
V
o
la
tilitie
s
Days to Expiration
Front SDDBPV
Back SDDBPV
Front SDDBSV
Back SDDBSV
SMFM Lester Ingber
Eurodollar Volatility of Implied Volatility
The top gure shows the Basis-Point Implied Volatility (BPIV) of Front and Back
contracts.
The bottom gure shows the standard deviation of differenced Basis-Point Implied
Volatility (SDDBPIV) of Front and Back contracts. Note that, similar to the results
with historical volatilities, this illustrates that the volatility of the implied
volatilities appears to be a stochastic process with constant diffusion for times less
than 30 days before expiration; afterwards, the values still are within the same
scale.
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
-120 -100 -80 -60 -40 -20 0
B
a
s
is
-
P
o
in
t Im
p
lie
d
V
o
la
tility
Days to Expiration
Front BPIV
Back BPIV
0.001
0.002
0.003
0.004
0.005
0.006
0.007
0.008
0.009
0.01
-90 -80 -70 -60 -50 -40 -30 -20 -10 0
S
ta
n
d
a
r
d
D
e
v
ia
tio
n
s
o
f D
iffe
r
e
n
c
e
d
B
a
s
is
-
P
o
in
t Im
p
lie
d
V
o
la
tility
Days to Expiration
Front SDDBPIV
Back SDDBPIV
SMFM Lester Ingber
Po wer-Law Model
There is growing evidence that the Black-Scholes lognormal distribution has been
less and less descriptive of markets over the past two decades. An example of a
generalization of the lognormal distribution is
dS/F(S, x) dt + dw
S
F(S, S
0
, S

, x, y)

S,
S
x
S
1x
0
,
S
y
S
1x
0
S
xy

,
S < S
0
S
0
S S

S > S

where S
0
and S

are selected to lie outside the data region used to t the other
parameters, e.g., S
0
1 and S

20 for ts to Eurodollar futures. We hav e used

the Black-Scholes form F S inside S < S
0
to obtain the usual benets, e.g., no
negative prices as the distribution is naturally excluded from S < 0, preservation of
put-call parity, etc. We hav e taken y 0 to reect total ignorance of markets
outside the range of S > S

.
SMFM Lester Ingber
Multi-Factor Volatility Model
Any study that geared to perform ASA ts of multivariate Lagrangians and
PATHINT long-time calculations can also consider another variable , stochastic
volatility, that can generalize the BS lognormal distribution:
dS/F(S, x) dt + dw
S
d + dw

The drawback of the two-factor PATHINT code is that it is slow. Howev er, it is
accurate and robust so we can process any diffusion for general x.
SMFM Lester Ingber
PATHINT
PATHINT is being used to perform European and American, one-factor and two-
factor, PATHINT calculations. Some examples are F(S, S
0
, S

, x, y) dz
S
for x in
-1, 0, 1, 2.
The short-time probability distribution at time T 0. 5 years for x 1, the
(truncated) Black-Scholes distribution. The short-time probability distribution at
time T 0. 5 years for x 0, the normal distribution. The short-time probability
distribution at time T 0. 5 years for x 1. The short-time probability
distribution at time T 0. 5 years for x 2.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
3.5 4 4.5 5 5.5 6 6.5 7
L
o
n
g
-
T
i
m
e

P
r
o
b
a
b
i
l
i
t
y
Price
(a) x = 1
x = 1
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
3 3.5 4 4.5 5 5.5 6 6.5 7
L
o
n
g
-
T
i
m
e

P
r
o
b
a
b
i
l
i
t
y
Price
(b) x = 0
x = 0
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
3 3.5 4 4.5 5 5.5 6 6.5
L
o
n
g
-
T
i
m
e

P
r
o
b
a
b
i
l
i
t
y
Price
(c) x = -1
x = -1
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
3.5 4 4.5 5 5.5 6 6.5 7
L
o
n
g
-
T
i
m
e

P
r
o
b
a
b
i
l
i
t
y
Price
(d) x = 2
x = 2
SMFM Lester Ingber
PATHINT Two-Factor
The two-factor distribution at time T 0. 5 years for x 0. 7.
Two-Factor Probability
3.75
4
4.25
4.5
4.75
5
5.25
5.5
5.75
6
6.25
Price
0.16
0.165
0.17
0.175
0.18
0.185
0.19
0.195
Volatility
0
100
Long-Time Probability
SMFM Lester Ingber
x Market Indicators
We hav e developed xs as indicators of different market contexts. E.g., x may be
-2 for some quarter and +2 for a different quarter.
(a) Weekly two-month moving-averaged one-factor and two-factor exponents for
ED contract expiring in September 1999 during the period June 1998 through
March 1999. (b) Weekly two-month moving-averaged two-factor correlation for
this same data. (c) Raw price data used in ts for the above parameters. (d)
Implied-volatility data used in ts for the above parameters.
-3
-2
-1
0
1
2
0 40 80 120 160 200
x
Day
(a) Exponent
one-factor
two-factor
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
40 80 120 160 200
R
h
o
Day
(b) Correlation
Rho
94
94.2
94.4
94.6
94.8
95
95.2
95.4
95.6
95.8
96
0 40 80 120 160 200
P
r
i
c
e
Day
(c) ED Price
Price
10
12
14
16
18
20
22
24
26
0 40 80 120 160 200
I
m
p
V
o
l
Day
(d) ED Implied Volatility
ImpVol
SMFM Lester Ingber
Stochasticity: Volatility vs Exponent
The one-factor exponents exhibit a random process that is approximately dened as
a simple normal process
x
with mean
x
and standard deviation
x
,
x
dx
dt

x
+
x

x
When averaging over a sev eral month period, we can derive
x
0 and have
x
essentially span all xs. Howev er, it is clear that there are shorter periods of
stochastic x which can be modeled independently, yielding a one-factor x as an
indicator of market contexts.
Most important, the reasonable interpretation of our results is that suppression of
stochastic volatility in the one-factor model just leaks out into stochasticity of
parameters in the model, e.g., especially in x. By comparison, the x-exponents in
the two-factor ts are quite stable.
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
4
0 40 80 120 160 200
M
o
m
e
n
t
Day
dx Moments
mean dx
StdDev dx
SMFM Lester Ingber
BS vs CRR vs PATHINT
Calculation of prices and Greeks are given for closed form BS, binomial tree
CRR
European
, CRR
American
, CRR
variant
, and PATHINT. All CRR calculations include
av eraging over 300 and 301 iterations to minimize oscillatory errors.
Greek BS CRR
European
CRR
American
CRR
variant
PATHINT
Price 0.138 0.138 0.138 0.138 0.138
Delta 0.501 0.530 0.534 0.506 0.501
Gamma 1.100 1.142 1.159 1.116 1.100
Theta -0.131 -0.130 -0.132 -0.133 -0.131
Rho -0.0688 -0.0688 -0.0530 -0.0530 -0.0688
Ve ga 1.375 1.375 1.382 1.382 1.375
The other parameters are S 5, S
0
0. 5, S

20, y 0.
SMFM Lester Ingber
Tick Resolution CMI Trading
We hav e tested a prototype of CMI trading on S&P using minute resolution data.
This looks promising enough to consider for current research projects.