Physica A 362 (2006) 225239

Minireview
The application of continuous-time random walks
in nance and economics
Enrico Scalas
Dipartimento di Scienze e Tecnologie Avanzate, Universita` del Piemonte Orientale, Via Bellini, 25 g I-15100 Alessandria, Italy
Received 26 August 2005; received in revised form 20 October 2005
Available online 13 December 2005
Abstract
This paper reviews some applications of continuous time random walks (CTRWs) to Finance and Economics. It is
divided into two parts. The rst part deals with the connection between CTRWs and anomalous diffusion. In particular, a
simplied version of the well-scaled transition of CTRWs to the diffusive or hydrodynamic limit is presented. In the second
part, applications of CTRWs to the ruin theory of insurance companies, to growth and inequality processes and to the
dynamics of prices in nancial markets are outlined and briey discussed.
r 2005 Elsevier B.V. All rights reserved.
Keywords: Continuous time random walks; Fractional calculus; Finance; Economics; Econophysics
1. Introduction
In 1965, Montroll and Weiss published a paper on continuous-time random walks (CTRWs) [1], in which
the waiting-time between two consecutive jumps of a diffusing particle is a real positive stochastic variable. It
was the starting point for several developments on the physics of normal and anomalous self-diffusion.
Anomalous relaxation with power-law tails of the waiting-time density was investigated by Montroll and
Scher who used Monte Carlo simulations [2]. Many papers were devoted by Shlesinger, Tunaley and other
authors to the long-time asymptotic behaviour of CTRWs [37] (see also Ref. [8]). The relevance of the
Mittag-Lefer function in anomalous relaxation was discussed by Caputo and Mainardi [9].
Further developments on the theory of CTRWs, including the problem of anomalous relaxation, can be
found in the following references [1023]. A book by ben-Avraham and Havlin discusses the applications of
the formalism presented in the aforementioned papers to real physical systems [24].
The asymptotic relation between properly scaled CTRWs with power-law distributed waiting times and
fractional diffusion processes was rigorously analysed by Balakrishnan already in 1985, dealing with
anomalous diffusion in one dimension [25], 4 years before the publication of the fundamental paper by
Schneider and Wyss on the analytic theory of fractional diffusion and wave equations [26]. Later, many other
authors studied this subject from slightly different viewpoints [2737]. The correspondence between CTRWs
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with Mittag-Lefer distributed waiting times and the time-fractional diffusion equation has been lucidly
worked out and explained in Ref. [30] by Hilfer and Anton (see also Refs. [38,39]). They have shed light on the
relevance of the Mittag-Lefer function, but their specic aims, methods and interpretations are completely
different from those of Balakrishnan. However, it must be recognized that already Balakrishnan has found, as
the natural choice for the waiting-time in CTRWs approximating fractional diffusion, the waiting-time density
whose Laplace transform is (in the notation used in this paper) 1=1 cs
b
, where c is a positive constant.
Implicitly, this is the Mittag-Lefer waiting-time distribution presented in Section 2 of this paper.
This intense theoretical activity has been thoroughly reviewed by Metzler and Klafter [17,40] and by
Piryatinska et al. [41] and is well known among physicists working on anomalous diffusion. It is less popular
in the interdisciplinary eld of Econophysics. The application of CTRWs to various problems in Finance and
Economics is even less known. Already in 1903, the pioneering thesis of Philip Lundberg led to the
Crame rLundberg theory of insurance failure, where claims to be paid by an insurance company are modelled
via a compound Poisson process, an instance of CTRW [42,43]. Moreover, mathematicians and probabilists
have given several important and interesting contributions to the theory of CTRWs [4450]. Unfortunately,
the various communities that study and use CTRWs ignore each other and results in one eld are not always
taken into account in other elds.
The present review paper is intended as a rst attempt to ll this gap, at least for physicists, and give some
pointers to the relevant literature. It is divided as follows. Section 2 is devoted to the theory of CTRWs and
their connection with the so-called fractional diffusion equation. This material has already been presented in
this form in Ref. [51], where only applications to nance are discussed. Section 3 describes applications of
CTRWs to the theory of insurance failure, to the theory of growth and inequality in Economics and to high-
frequency price dynamics in nancial markets. Finally, in Section 4, conclusions are drawn and directions for
future research outlined.
It must be remarked that the applications of CTRWs to Finance and Economics listed above and studied
below reect the interest of the author and are not the only possibilities. Various applications are possible in
the eld of queueing theory and it is worth mentioning the work of Hilfer on sales forecast and planning [52].
It is the hope of the present author to encourage further research on the applications of CTRWs to
interdisciplinary problems. As the reader will see, they are a very useful and handy theoretical tool and it is
possible to generalize them to more complex processes that can always be studied by means of Monte Carlo
simulations, if not analytically. However, this review paper also reects knowledge limits and is still far from a
complete coverage of the subject.
2. Theory
CTRWs are point processes with reward [45], a special instance of pure jump processes. The point process is
characterized by a sequence of independent identically distributed (i.i.d.) positive random variables t
i
, which
can be interpreted as waiting times between two consecutive events:
t
n
t
0

n
i1
t
i
; t
n
t
n1
t
n
; n 1; 2; 3; . . . ; t
0
0. (1)
Pure jump processes are Markovian if and only if the waiting times follow the exponential distribution [49].
The rewards are i.i.d. random variables: x
i
. In the usual physical interpretation, the x
i
s represent the
instantaneous jumps of a diffusing particle, and they can be n-dimensional vectors. If diffusion takes place on
an n-dimensional lattice, these jumps occur between discrete positions x
j
, where j is an integer index. In this
paper, only the one-dimensional case is studied, and both jumps and positions are considered as continuous
variables, but the extension of many results to the n-dimensional case and to lattices is straightforward. The
position x of the particle at time t is given by the following sum (with the random variable nt dened by
nt maxfm : t
m
ptg and x0 0):
xt

nt
i1
x
i
. (2)
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E. Scalas / Physica A 362 (2006) 225239 226
In the next section, the rewards x
i
s as well as the positions xt will assume different meanings according to the
specic problem addressed. The time series fxt
i
g can be characterized by jx; t, the joint probability density
of jumps x
i
xt
i1
xt
i
and of waiting times t
i
t
i1
t
i
. The joint density satises the normalization
condition
_ _
dx dt jx; t 1. It must be again remarked that both x
i
and t
i
are assumed to be independent
and identically distributed (i.i.d.) random variables. This strong assumption is useful to derive limit theorems
for the stochastic processes described by CTRWs. However, in various applications, the presence of
heteroskedasticity, as well as correlations between waiting times do falsify the i.i.d hypothesis. This is the case
in nance. The reader interested in a review on correlated random variables is referred to Chapter 8 in
McCauleys recent book [53].
In general, jumps and waiting times are not independent from each other [54]. Probabilistic arguments (see
Refs. [1,37,55]) can be used to derive the following integral equation that gives the probability density, px; t,
for the particle of being in position x at time t, conditioned by the fact that it was in position x 0 at time
t 0:
px; t dxCt
_
t
0
_
1
1
jx x
0
; t t
0
px
0
; t
0
dt
0
dx
0
, (3)
where dx is Diracs delta function and Ct is the so-called survival function. Ct is related to the marginal
waiting-time probability density ct. The two marginal densities ct and lx are:
ct
_
1
1
jx; t dx,
lx
_
1
0
jx; t dt 4
and the survival function Ct is
Ct 1
_
t
0
ct
0
dt
0

_
1
t
ct
0
dt
0
. (5)
Eq. (3) is generally valid for pure jump processes and its derivation can be found also in introductory
textbooks on stochastic processes [49]. It can be obtained by recalling the meaning of the survival function: the
probability of no jumps taking place up to time t. The rst term in the sum on the right-hand side takes into
account the permanence in x 0 up to time t, whereas the second term gives the probability density of
jumping from the position x
0
at time t
0
to the position x at time t. If waiting times are exponentially
distributed, CTRWs are also known as compound Poisson processes. In this case, CTRWs are Markovian
processes that belong to the class of Le vy processes, that is processes with stationary and independent
increments with the distribution characterized by the one point probability density px; t being innitely
divisible. Conversely, for every innite divisible distribution, there exists a corresponding Le vy process [56].
The integral equation (3), can be solved in the LaplaceFourier domain. The Laplace transform, gs of a
(generalized) function gt is dened as
gs
_
1
0
dt e
st
gt, (6)
whereas the Fourier transform of a (generalized) function f x is dened as

f k
_
1
1
dxe
ikx
f x. (7)
A generalized function is a distribution (like Diracs d) in the sense of Sobolev and Schwartz [57].
One gets:

pk; s

Cs
1
1

jk; s
, (8)
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E. Scalas / Physica A 362 (2006) 225239 227
or, in terms of the density ct:

pk; s
1

cs
s
1
1

jk; s
, (9)
as, from Eq. (5), one has
Cs
1

cs
s
. (10)
In order to obtain px; t, it is then necessary to invert its LaplaceFourier transform

pk; s. For jumps
independent from waiting times, a series solution to the integral equation (3) exists. This will be derived in the
next subsection.
2.1. Limit theorems: the uncoupled case
In the so-called uncoupled case, the joint probability density of jumps and waiting times can be written as
the product of the two marginal densities:
jx; t lxct, (11)
with the normalization conditions
_
dx lx 1 and
_
dt ct 1. This case has been discussed by Goreno,
Mainardi and the present author [37]. In the following, the main results of that paper are summarized and
presented in a simplied version that uses the method of the characteristic function to obtain the diffusive limit
of the CTRW.
In the uncoupled case, the integral master equation for px; t becomes:
px; t dxCt
_
t
0
ct t
0

_
1
1
lx x
0
px
0
; t
0
dx
0
_ _
dt
0
. (12)
This equation has an explicit solution in terms of Pn; t, the probability of n jumps occurring up to time t, and
of the n-fold convolution of the jump density, l
n
x:
l
n
x
_
1
1
. . .
_
1
1
dx
n1
. . . dx
1
lx x
n1
. . . lx
1
. (13)
Indeed, Pn; t is given by
Pn; t
_
t
0
c
n
t tCt dt, (14)
where c
n
t is the n-fold convolution of the waiting-time density:
c
n
t
_
t
0
. . .
_
t
1
0
dt
n1
. . . dt
1
ct t
n1
. . . ct
1
. (15)
The n-fold convolutions dened above are probability density functions for the sum of n independent
variables. Eqs. (13) and (15) can be used thanks to the i.i.d. hypothesis.
Using the LaplaceFourier method and recalling the properties of LaplaceFourier transforms of
convolutions, one gets the following solution of the integral equation [37,5860]:
px; t

1
n0
Pn; tl
n
x. (16)
Eq. (16) can be directly derived by pure probabilistic considerations from Eq. (2) and used as the starting point
to derive Eq. (12) via the transforms of Fourier and Laplace, as it describes a jump process subordinated to a
renewal process [6163].
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It is now interesting to consider the following pseudodifferential equation, giving rise to anomalous
relaxation and power-law tails in the waiting-time probability [9]:
d
b
dt
b
Ct Ct; t40; 0obp1; C0

1, (17)
where the operator d
b
=dt
b
is the Caputo fractional derivative, related to the RiemannLiouville fractional
derivative. For a sufciently well-behaved function f t, the Caputo derivative [64] is dened by the following
equation, for 0obo1:
d
b
dt
b
f t
1
G1 b
d
dt
_
t
0
f t
t t
b
dt
t
b
G1 b
f 0

(18)
and reduces to the ordinary rst derivative if b 1. The Laplace transform of the Caputo derivative of a
function f t is
L
d
b
dt
b
f t; s
_ _
s
b

f s s
b1
f 0

. (19)
If Eq. (19) is applied to the Cauchy problem of Eq. (17), one gets:

Cs
s
b1
1 s
b
. (20)
Eq. (20) can be inverted, giving the solution of Eq. (17) in terms of the Mittag-Lefer function of parameter b
[9,65,66]:
Ct E
b
t
b
, (21)
dened by the following power series in the complex plane:
E
b
z:

1
n0
z
n
Gbn 1
. (22)
The Mittag-Lefer function is a possible model for a fat-tailed survival function. For b 1, the Mittag-Lefer
function coincides with the ordinary exponential function. In the other cases, for small t, the Mittag-Lefer
survival function coincides with the stretched exponential:
Ct E
b
t
b
1
t
b
Gb 1
expft
b
=Gb 1g; 0pt51, (23)
whereas for large t, it has a power-law asymptotic representation:
Ct$
sinbp
p
Gb
t
b
; 0obo1; t ! 1. (24)
Accordingly, for small t, the probability density function of waiting times ct dCt=dt behaves as
ct
d
dt
E
b
t
b

t
1b
Gb
; 0pt51 (25)
and the asymptotic representation is
ct$
sinbp
p
Gb 1
t
b1
; 0obo1; t ! 1. (26)
The Mittag-Lefer function is important as, without passage to the diffusion limit, it leads to a time-fractional
master equation, just by insertion into the CTRW integral equation. This fact was discovered and made
explicit for the rst time in 1995 by Hilfer and Anton [38], who gave a rigorous proof of equivalence between
CTRWs and fractional diffusion. Therefore, this special type of waiting-time law (with its particular properties
of being singular at zero, completely monotonic and long-tailed) may be best suited for approximate CTRW
Monte Carlo simulations of fractional diffusion.
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For processes with survival function given by the Mittag-Lefer function, the solution of the master
equation can be explicitly written [37] as
px; t

1
n0
t
bn
n!
E
n
b
t
b
l
n
x, (27)
where
E
n
b
z:
d
n
dz
n
E
b
z.
The Fourier transform of Eq. (27) is the characteristic function of px; t and is given by
^ pk; t E
b
t
b

^
lk 1. (28)
If log-returns and waiting times are scaled according to
x
n
h hx
1
hx
2
hx
n
(29)
and
t
n
r rt
1
rt
2
rt
n
, (30)
the scaled characteristic function becomes:
^ p
h;r
k; t E
b
t
b
r
b

^
lhk 1
_ _
. (31)
Now, if we assume the following asymptotic behaviours for vanishing h and r:
^
lhk$1 h
a
jkj
a
; 0oap2 (32)
and
lim
h;r!0
h
a
r
b
1, (33)
we get that
lim
h;r!0
^ p
h;r
k; t ^ uk; t E
b
t
b
jkj
a
. (34)
The Laplace transform of Eq. (34) is

uk; s
s
b1
jkj
a
s
b
. (35)
Therefore, the well-scaled limit of the CTRW characteristic function coincides with the Green function of the
following pseudodifferential fractional diffusion equation:
jkj
a

uk; s s
b

uk; s s
b1
, (36)
with ux; t given by
ux; t
1
t
b=a
W
a;b
x
t
b=a
_ _
, (37)
where W
a;b
u is
W
a;b
u
1
2p
_
1
1
dke
iku
E
b
jkj
a
, (38)
the inverse Fourier transform of a Mittag-Lefer function [17,36,37,40,67,68].
For b 1 and a 2, the fractional diffusion equation becomes the ordinary diffusion equation and the
function W
2;1
u is nothing else but the Gaussian probability density function evolving in time with a variance
s
2
2t. In the general case (0obo1 and 0oao2), the function W
a;b
u is still a probability density evolving
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E. Scalas / Physica A 362 (2006) 225239 230
in time, and it belongs to the class of Fox H-type functions that can be expressed in terms of a Mellin-Barnes
integral as shown in details in Ref. [67].
The scaling equation, Eq. (33), can be written in the following form:
h r
b=a
. (39)
If b 1 and a 2, one can recognize the scaling relation typical of Brownian motion (or the Wiener process).
In the passage to the limit outlined above,

p
r;h
k; s and

uk; s are asymptotically equivalent in the
LaplaceFourier domain. Then, the asymptotic equivalence in the spacetime domain between the master
equation and the fractional diffusion equation is due to the continuity theorem for sequences of characteristic
functions, after the application of the analogous theorem to sequences of Laplace transforms [48]. Therefore,
there is convergence in law or weak convergence for the corresponding probability distributions and densities.
Here, weak convergence means that the Laplace transform and/or Fourier transform (characteristic function)
of the probability density function are pointwise convergent (see Ref. [48]).
In Eq. (28), let b 1. This case corresponds to exponentially distributed waiting times and one has:
^ pk; t expt
^
lk 1 exp
^
lk 1
t
^ pk; 1
t
, (40)
which is a property valid for characteristic functions of Le vy processes. In the case b 1, the limiting
probability density (Eq. (37)) becomes:
ux; t
1
t
1=a
W
a;1
x
t
1=a
_ _
, (41)
where
W
a;1
u
1
2p
_
1
1
dke
iku
expjkj
a
. (42)
The distribution dened by the probability density ux; t in Eq. (41) turns out to be innite divisible and, for
0oao2, there are corresponding Le vy processes that are called a-stable Levy ights [69]. For a 2 the
corresponding Le vy process is the BachelierWiener process.
For 0obo1, Eq. (28) cannot be written in the form of Eq. (40). The generalized compound Poisson
processes are not Le vy processes and they are non-Markovian, and this is true also in the diffusive limit.
2.2. Limit theorems: the coupled case
The diffusive limit in the coupled case is well discussed by Meerschaert et al. [34] based on the ndings of
Meerschaert and Schefer [70]. The coupled case is relevant as, in general, jumps and waiting times are not
independent [54,71]. Here, a condition that sufces to obtain the limiting pseudodifferential equation (36) will
be given. This micro-theorem appeared for the rst time in heuristic form in Ref. [72] and the rigorous proof
was submitted to the proceedings of FDA 04 [73]. It is based on the results summarized in Ref. [37] and
discussed in Refs. [74,75].
Theorem. Let jx; t be the (coupled) joint probability density of a CTRW. If, under the scaling x ! hx and
t ! rt, the Fourier Laplace transform of jx; t behaves as follows:

j
h;r
k; s

jhk; rs (43)
and if, for h ! 0 and r ! 0, the asymptotic relation holds:

j
h;r
k; s

jhk; rs$1 mjhkj
a
nrs
b
, (44)
with 0oap2 and 0obp1, then, under the scaling relation mh
a
nr
b
, the solution of the (scaled) coupled CTRW
master (integral) equation, Eq. (3), p
h;r
x; t, weakly converges to the Green function of the fractional diffusion
equation, ux; t, for h ! 0 and r ! 0.
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Proof. The FourierLaplace transform of the scaled conditional probability density p
h;r
x; t is given by

p
h;r
k; s
1

crs
s
1
1

jhk; rs
. (45)
Replacing Eq. (44) in Eq. (45) and observing that

cs

j0; s, one asymptotically gets for small h and r:

p
h;r
k; s$
nr
b
s
b1
nr
b
s
b
mh
a
jkj
a
, (46)
which for vanishing h and r, under the hypotheses of the theorem, converges to

p
0;0
k; s

uk; s
s
b1
s
b
jkj
a
, (47)
where

uk; s is the FourierLaplace transform of the Green function of the fractional diffusion equation (see
Eq. (36)). The asymptotic equivalence in the spacetime domain, between p
0;0
x; t and ux; t, the inverse
FourierLaplace transform of

uk; s, is again ensured by the continuity theorem for sequences of
characteristic functions, after the application of the analogous theorem for sequences of Laplace transforms
[48]. There is convergence in law or weak convergence for the corresponding probability distributions and
densities. &
An important consequence of the above theorem is the following corollary showing that, in the case of
marginal densities with nite rst moment of waiting times and nite second moment of jumps, the limiting
density ux; t is the solution of the ordinary diffusion equation (and thus the limiting process is the Wiener
process).
Corollary. If the Fourier Laplace transform of jx; t is regular for k 0 and s 0, and, moreover, the
marginal waiting-time density, ct, has nite rst moment, t
0
, and the marginal jump density, lx, is symmetric
with nite second moment, s
2
, then the limiting solution of the master (integral) equation for the coupled CTRW
is the Green function of the ordinary diffusion equation.
Proof. Due to the hypothesis of regularity in the origin and to the properties of Fourier and Laplace
transforms, we have that:

j
h;r
k; s

jhk; rs$

j0; 0
1
2
q
2

j
qk
2
_ _
0;0
h
2
k
2

j
qs
_ _
0;0
rs
1
s
2
2
h
2
k
2
t
0
rs 48
and as a consequence of the theorem, under the scaling h
2
s
2
=2 t
0
r, one gets, for vanishing h and r:

p
0;0
k; s

uk; s
1
s k
2
, (49)
corresponding to the Green function (36) for a 2 and b 1, that is the solution of the Cauchy problem for
the ordinary diffusion equation. &
3. Applications
In this section, three applications of CTRWs outside the realm of Physics will be presented. In all the three
cases, there will be a discussion of the pioneering work that introduced the CTRW model and a short
description of some recent developments related to the theory outlined in the previous section. Each of these
applications would deserve a larger review, but pointers to relevant books and papers, if available, will be
provided. The three applications are listed in chronological order of appearance, to the best of the knowledge
of the author. The rst one is the theory of ruin probability in insurance, introduced by Lundberg in 1903 [42].
The second application is based on Gibrats research on inequality in Economics and can be traced to Gibrats
ARTICLE IN PRESS
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monograph published in 1931 [76]. Finally, the rst application of CTRWs to price uctuations appeared in a
paper written by Press in 1967 [77].
3.1. Theory of ruin probability in insurance
The theory of ruin probability for insurance companies is based on the following equation for the risk
process, that gives the capital R of such companies at time t [42,43,78,79]:
Rt u ct

nt
i1
x
i
, (50)
where u is the initial capital, c is the ux of capital due to the premium payment, and x
i
is a non-negative
random variable representing the claims paid up to time t. Thus, the process of claim arrival is a CTRW where
the jumps can only be zero or in the positive direction.
Ruin occurs when the capital Rt becomes zero. For a given claim process, the time to ruin depends on the
initial capital u and is dened as
tu infftX0 : Rto0g. (51)
In this theory, other important quantities are the ruin probability in innite time, qu, that is the probability
that tu is a nite quantity:
qu Prtuo1 (52)
and, given a nite time horizon, T, the ruin probability in nite time, qu; T:
qu; T PrtuoT. (53)
The ruin probability in nite time can be always estimated by means of Monte Carlo simulations, whereas the
ruin probability in innite time is only accessible through theoretical considerations [80].
As the analytical expressions, if available, of the ruin probability are rather cumbersome [79,81,82], some
authors proposed to approximate the claim process by Brownian motion [83,84]. Recently, Furrer and co-
workers applied this idea by means of the weak convergence theory outlined in the previous section in order to
approximate the claim process by Brownian motion and a-stable Le vy motion [85,86].
They consider claims whose distribution belongs to the basin of attraction of a Le vy a-stable density
L
a
u W
a;1
u. In this hypothesis, they are able to derive the following approximation of the risk process:
R
a
t u ct l
1=a
D
a
t, (54)
where D
a
t is a Le vy ight with unitary scale parameter, and u, c, l are positive constants.
Furrer has shown that the innite time ruin probability for the previous approximated risk process is [87]:
qu

1
n0
a
n
G1 a 1m
u
a1n
, (55)
where a cl
1
cospa 2=2.
3.2. Growth and inequality
The title of the book written by Gibrat is already a sort of manifesto [76]: Economic inequalities,
application: to inequalities in wealth, in the concentration of enterprises, in the population of towns, in the
statistics of families, etc., on a new law, the law of proportional effect. Gibrat claims the discovery of a simple
law that can explain the origin of inequalities within Economic growth processes. Similar themes pervade
much of the recent Econophysics literature [88,89].
A very simple non-conservative model that takes into account the ideas of Gibrat is the following:
s
i
n 1 Zns
i
n, (56)
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E. Scalas / Physica A 362 (2006) 225239 233
where s
i
n represent the size of agent i and Zn is a random variable always extracted from the same
probability distribution at any discrete period n.
Eq. (56) is a growth model with multiplicative noise. It is the basis on which the so-called generalized
LotkaVolterra models are built [90]. In this model, there are no direct or indirect interactions between the
agents and the logarithm of the size, xn logsn, is the sum of independent and identically distributed
random variables, the growth rates, x logZ:
xn 1 x0

n
m1
xm. (57)
If the growth rate is independent from the size, the Central Limit Theorem and its generalizations apply in the
large n limit [91] and one gets either normal or Le vy distributed log-sizes and, therefore, log-normal or log-
Le vy distributed sizes.
In a situation in which the growth shocks x can arrive at random times instead of at xed periods, Eq. (57)
must be replaced by its continuous-time version, given by the non-homogeneous case of Eq. (2):
xt x0

nt
m1
x
m
, (58)
where nt maxfm : t
m
ptg.
These ideas have been recently applied by a group of Italian economists to models of rm growth [9295]. It
is important to remark that, as shown in the previous section, px; t follows either a normal or anomalous
diffusive behaviour. Therefore, in the description of growth and inequality processes by means of Eq. (58),
there is no equilibrium asymptotic probability density. On the contrary, conservative inequality processes also
known as pure money exchange processes, such as those introduced by Angle and Bennati [96,97], do yield
equilibrium distributions. Such conservative models are not suitable to describe economic growth, however.
3.3. High-frequency price uctuation in nancial markets
The mapping between CTRWs and high-frequency price uctuations in nancial markets was proposed in
Ref. [72] along the lines presented in the papers by Clark and Parkinson [62,98]. Price dynamics is described in
a pure phenomenological way. No assumption on the rationality or the behaviour of trading agents is
necessary and also the efcient market hypothesis [99,100] can be neglected. Yet, the celebrated geometric
Brownian motion model for nancial price uctuations [101] is a straightforward consequence of the mapping
if some restrictive assumptions are considered [51,102].
Let St denote the price of an asset at time t. In a real market with a double-auction mechanism, prices are xed
when buy orders are matched with sell orders and a transaction (trade) occurs. Waiting times between two trades
are a random variable. It is more convenient to refer to returns rather than prices. For this reason, the variable
xt log St is studied: the logarithm of the price or log-price. For a small price variation DS St
i1
St
i
,
the return r DS=St
i
and the logarithmic return r
log
logSt
i1
=St
i
virtually coincide. In the nancial inter-
pretation, the jumps x
i
s have the meaning of log-returns, whereas the rewards xt represent log-prices at time t.
The revisited and augmented CTRW formalism has been applied to high-frequency price dynamics in
nancial markets by our research group since 2000, in a series of three papers [72,55,103]. Later, the present
author discovered a paper written by Press and published in 1967, where an instance of CTRWs was used: the
so-called normal compound Poisson processes [77]. Other scholars have recently investigated this formalism
[104107], and new extensive data analyses based on the formalism have been performed [108110].
The normal compound Poisson process has an exponential marginal waiting-time density c with average t
0
and a normal jump density, l with variance s
2
and average y. Therefore, taking into account that the n-fold
convolution of a normal density is still normal, with variance ns
2
and average ny, and that for ct
expt=t
0
=t
0
one has Pn; t expt=t
0
t=t
0

n
=n!; Eq. (16) yields for px; t:
px; t expt=t
0

1
n0
t=t
0

n
n!
1

2pn
p
s
expx ny
2
=2ns
2
. (59)
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E. Scalas / Physica A 362 (2006) 225239 234
It is important to remark that, if the waiting times are exponentially distributed, then the number of jumps up
to time t follows the Poisson distribution and vice versa. The normal compound Poisson process is Markovian
and, in the diffusive limit, its density is the Green function of the normal diffusion equation. Therefore, the
limiting density for the log-price is normal and for the price is log-normal. Indeed, the geometric Brownian
motion model is the limiting process for any compound Poisson process where rewards have a nite second
moment. A third remark is the following. If one considers the distribution of log-returns sampled at xed time
intervals, Dx xt Dt xt, because of the stationarity and homogeneity of the process, one has that
pDx px; Dt. It is possible to show that, in the case of a symmetric density (y 0), one has for the kurtosis
of Dx:
b
2
3
t
0
Dt
. (60)
Therefore, if a normal compound Poisson process is sampled at xed times, with a sampling interval Dt, the
distribution of log-returns, Dx, can be either leptokurtic b
2
43, or mesokurtic b
2
3, or platykurtic b
2
o3
depending on the ratio t
0
=Dt.
Our group has studied the independence between log-returns and waiting times for stocks traded at the New
York Stock Exchange in October 1999. A contingency-table analysis performed on general electric (GE) prices
shows that the null hypothesis of independence can be rejected with a signicance level of 1% [54]. We have
also discussed the anomalous non-exponential behaviour of the unconditional waiting-time distribution
between tick-by-tick trades both for future markets [55] and for stock markets [54,102]. Different waiting-time
scales have been investigated in different markets by various authors. All these empirical analyses corroborate
the waiting-time anomalous behaviour. A study on the waiting times in a contemporary FOREX exchange
and in the XIXth century Irish stock market was presented by Sabatelli et al. [111]. They were able to t the
Irish data by means of a Mittag-Lefer function as our group did before in a paper on the waiting-time
marginal distribution in the German-bund future market [55]. Kyungsik Kim and Seong-Min Yoon studied
the tick dynamical behaviour of the bond futures in Korean Futures Exchange (KOFEX) market and found
that the survival probability displays a stretched-exponential form [112]. Finally, Ivanov et al. [113] conrmed
that a stretched-exponential ts well the survival distribution for NYSE stocks as we suggested in Ref. [54]. In
order to stress the relevance of non-exponentially distributed waiting times, let this author recall that a power-
law distribution has been detected by Kaizoji and Kaizoji in analysing the calm time interval of price changes
in the Japanese market [114] and Barabasi has noticed that non-Poissonian processes characterize the activity
of human beings [115,116]. In the case of nancial markets, our group has conrmed that also waiting times
between orders do not follow the exponential distribution and has offered an explanation in terms of variable
human activity during trading days [102,117]. Finally, Muchnik and Solomon have recently developed a
general simulation platform called NatLab in order to simulate agent-based asynchronous processes [118].
The results mentioned above can be further put into context and related to mainstream nancial and
mathematical nance research on price dynamics [119,120]. Recently, thanks to the availability of large high
frequency and tick-by-tick data sets, there has been an increasing interest on the statistical properties of high-
frequency nancial data related to market microstructural properties [121126]. High-frequency econometrics
is also well established after research on autoregressive conditional duration models [127130].
The remark that in high-frequency nancial data not only returns but also waiting times between
consecutive trades are random variables can be found in Ref. [131]. This remark is also present in a paper by
Lo and MaKinley [132], but it can be traced at least to papers on the application of compound Poisson
processes [77] and subordinated stochastic processes [61,62] to nance. Models of tick-by-tick nancial data
based on compound Poisson processes can also be found in the following references by Rydberg and Shephard
[133135].
4. Conclusions
This paper contains an outline of the theory of CTRWs as well as a discussion of their application to the
theory of ruin for insurance companies, to Gibrats model for growth and inequality, and to price dynamics in
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E. Scalas / Physica A 362 (2006) 225239 235
nancial markets. Originally introduced in Physics as models for normal and anomalous self-diffusion,
CTRWs turn out to be useful tools in many other elds of human knowledge.
In the scientic literature, instances and generalizations of CTRWs appear under different labels such as:
compound Poisson processes, point processes with reward, pure jump processes with i.i.d. jumps. Some of
these processes have been already in use in the ruin theory of insurance since the beginning of the XXth
century, well before the paper by Montroll and Weiss [1].
The application to ruin theory is mature and it does not deserve more comments in this nal section.
On the contrary, as for the application to growth and inequality, this is rather new and work by various
authors is in progress. It is highly likely that the idea of growth shocks arriving at random times will foster
further empirical research on rm growth.
As shown in Section 3.3, the statistical behaviour of returns sampled with a xed time step can be rather
different from the behaviour of tick-by-tick returns. In the language of rm growth this means that the
statistical properties of the yearly growth rate can dramatically differ from the properties of the distribution of
elementary shocks.
For what concerns nancial applications of CTRWs there are several possible extensions of the work
presented here [51].
First of all, one can abandon the hypothesis of i.i.d. log-returns and waiting times and consider various
forms of dependence. In this case, it is no longer possible to exploit the nice properties of Laplace and Fourier
transforms of convolutions, but, still, Monte Carlo simulations can provide hints on the behaviour of these
processes in the diffusive limit.
A second possible extension is to include volumes as a third stochastic variable. This extension is
straightforward, starting from a three-valued joint probability density.
A third desirable extension is to consider a multivariate rather than univariate model that includes
correlations between time series.
The present author is eager to know progress in any direction by other independent research groups in the
eld of applications of CTRWs to Finance and Economics. This will be very useful to maintain this review
up to date for future editions. He can be contacted at scalas@unipmn.it.
Acknowledgements
This work was supported by the Italian M.I.U.R. F.I.S.R. Project Ultra-high-frequency dynamics of
nancial markets. The author wishes to acknowledge useful discussion with J. Angle, G. Bottazzi, P. Buchen,
S. Focardi, G. Germano, R. Goreno, T. Kaizoji, H. Luckock, T. Lux, F. Mainardi, M. M. Meerschaert,
L. Muchnik, M. Raberto, A. Secchi, and S. Solomon.
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