Understanding volatility correlation behavior with a magnitude cross-correlation function

Abstract

We propose an approach for analyzing the basic relation between correlation properties of the original signal and its magnitude fluctuations by decomposing the original signal into its positive and negative fluctuation components. We use this relation to understand the following phenomenon found in many naturally occurring time series: the magnitude of the signal exhibits long-range correlation, whereas the original signal is short-range correlated. The applications of our approach to heart rate variability signals and high-frequency foreign exchange rates reveal that the difference between the correlation properties of the original signal and its magnitude fluctuations is induced by the time organization structure of the correlation function between the magnitude fluctuations of positive and negative components. We show that this correlation function can be described well by a stretched-exponential function and is related to the nonlinearity and the multifractal structure of the signals.