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# Evidence for a Massive Dark Object in NGC 4350

## 1 Introduction

There is increasing evidence that most galaxies with a large spheroidal component host a Massive Dark Object (MDO) at their centre, with masses ranging from $`10^8\mathrm{M}_{}`$ to $`210^{10}\mathrm{M}_{}`$ \[Ho, 1999\].

This evidence was first reviewed by Kormendy & Richstone \[Kormendy & Richstone, 1995\], suggesting that in kinematically hot galaxies (ellipticals and S0s) the mass of the central object $`M_{\mathrm{MDO}}`$ correlates with the mass of the hot stellar component $`M_{\mathrm{sph}}`$. For the ratio $`x\mathrm{log}(M_{\mathrm{MDO}}/M_{\mathrm{sph}})`$ they found a Gaussian distribution with average value $`x=2.5`$ and variance $`\sigma =0.2`$. More recently, assuming isotropy in the velocity dispersion tensor, Magorrian et al. \[Magorrian et al., 1998\] exploited the high resolution of HST photometry and ground based spectroscopy to estimate the MDO mass of 36 E/S0s, finding a similar correlation $`x=2.28\pm 0.5`$.

Exploiting the data from a sample of 30 galaxies, for which at least two independent MDO mass estimates are available, Salucci et al. \[Salucci et al., 1999\] found an average value $`x=2.60\pm 0.3`$, quite close to that obtained by Ho et al. \[Ho, 1999\] and Ford et al. \[Ford et al., 1999\]. This result has been used to determine the mass function of MDOs hosted in spheroidal galaxies and turns out to be fully consistent with the mass function of accreted matter required to fuel QSO activity. This supports the idea that MDOs are the remnant BHs of a past era of nuclear galactic activity.

On the other hand, using several hundred rotation curves, Salucci et al. \[Salucci et al., 2000\] recently put stringent upper limits on the mass of the MDOs resident in late-type galaxies, showing that they must be on average at least 10-100 times smaller than the ones claimed for ellipticals. If one assumes that MDOs are the remnants of past QSO activity, this implies that the contribution to the shining phase of quasars by BHs hosted in late-type spirals is totally negligible.

Finally, recent results \[Ferrarese & Merritt, 2000, Gebhardt et al., 2000a\] showed that the central MDO mass strongly correlates with the galaxy velocity dispersion. In particular Gebhardt et al. \[Gebhardt et al., 2000a\] pointed out that ellipticals and bulges fall again in a fundamental plane when they are located in a four-dimension plane with coordinates ($`M_{BH}\mathrm{log}L\mathrm{log}\sigma ,\mathrm{log}R_e`$). This property implies some fundamental connection between the black hole and the bulge.

In this context it is interesting to investigate the role of S0 and early-type disc galaxies. In view of their massive bulge, they must be considered as a possible location for QSO remnants. However, the search for central massive objects in S0 is hampered, as: (1) the bulge/disc photometric decomposition is often uncertain; (2) these objects have weak $`H\alpha `$ lines and, consequently, the rotation curve inside the central 0.5 kpc cannot be accurately determined; (3) the rotation curve is too disturbed by the strong asymmetric drift effects to be representative of the circular velocity.

Detection of MDOs in this kind of galaxy requires kinematic data of the innermost regions, and a detailed dynamic model. This approach has proved effective in detecting massive central dark objects in a few S0/Sa galaxies, including NGC 4594 \[Kormendy et al., 1996\], M31 \[Tsvetanov et al., 1998\], NGC 3115 \[Emsellem et al., 1999\], and NGC 4342 \[Cretton & Van Den Bosch, 1999\]. Given the highly compact stellar structure, central MDOs can only be detected through accurate reconstruction of the galactic components, including the bulge/disc decomposition.

The goal of this work is to investigate the possible presence of an MDO in the nucleus of the S0 galaxy NGC 4350, by applying the dynamical model of Pignatelli & Galletta \[Pignatelli & Galletta, 1999\] to recent data. This work has been set out as follows: in Section 2 we present the available data; in Section 3 we give a brief summary of the hypothesis and characteristics of the model; in Section 4 we derive the best-fit parameters of the model; Section. 5 is devoted to the discussion of the results and conclusions.

In this paper we assume a Hubble constant $`H_0=75`$ km s-1 Mpc-1.

## 2 The data

NGC 4350 is classified as a classical S0 galaxy in the Nearby galaxy catalog (Tully 1988; see Table 1). It is observed almost edge-on (from its axial ratio one can infer an inclination angle $`i>62^{}`$).

For the photometry, we adopt the R-band surface brightness profiles published by Seifert and Scorza \[Seifert & Scorza, 1996\]. According to these authors, NGC 4350 can be decomposed into disc and bulge components. The disc is probably exponential, significantly decreasing beyond 40 arcsec; the bulge on the other hand dominates even in the outer parts of the galaxy, as indicated by the substantial drop in the ellipticity profile. No ring-like component, or inner stellar disc has been detected.

For the kinematics, we adopt Fisher’s detailed stellar kinematical observations along the major and minor axis \[Fisher, 1997\]. These include the rotational velocity, the velocity dispersion profile, and the profiles of the Gauss-Hermite higher-order moments $`h_3`$, $`h_4`$ \[Van Der Marel & Franx, 1993\]. Moreover, they also include emission-line gas kinematics of a rapidly rotating nuclear disc. The total number of indipendent measurements to be simultaneously fitted by a model is 280.

The high rotational velocity of the nuclear gaseous disc, the rapid increase of the stellar rotation curve in the first $`2^{\prime \prime }`$ ($`160`$ pc) and the corresponding high peak in the velocity dispersion profile suggest the presence of a central concentration of mass.

Loyer et al. \[Loyer et al., 1998\] modeled this galaxy in some detail using a Multi-Gaussian Expansion method. In this paper, the photometric and kinematic data are reproduced with a different method and the subsequent analysis is extended to include the gas rotational velocity and the profiles of the $`h_3`$, $`h_4`$ parameters. As pointed out by several authors \[Van Der Marel, 1999, Cretton & Van Den Bosch, 1999, Gebhardt et al., 2000b\], the use of the higher moments of the line-of-sight velocity distribution is very relevant in determining the orbital anisotropies, thus reducing the uncertainties on the MDO mass.

## 3 The Galaxy Model

In order to investigate the gas and stellar kinematics we use the self-consistent dynamical technique of Pignatelli and Galletta \[Pignatelli & Galletta, 1999\]. We give here a brief summary of the technique and the general assumptions made.

A galaxy can be described by superposition of different components. For each component, we separately assume:

the density distribution is oblate, without triaxial structures;

the isodensity surfaces are similar concentric spheroids;

the surface density profile follows a simple $`r^{1/4}`$ or an exponential law;

the local velocity distribution is Gaussian;

the velocity dispersion is isotropic ($`\sigma _r=\sigma _\theta =\sigma _z`$);

the mass-luminosity ratio is constant with radius;

Our model does not consider the possible presence of triaxial structures (bar; triaxial bulge; tilted component; warp) or of anisotropy in the velocity distribution (with predominance of radial or tangential orbits).

The model has $`4n+2`$ free parameters, where $`n`$ is the number of adopted components: namely the luminosity, scale length, mass-luminosity ratio and flattening $`\{L_{tot},r_e,M/L,b/a\}`$ of each component plus the inclination angle of the galaxy and the mass of the central massive dark object $`M_{MDO}`$. In principle, photometry can be used to constrain all these parameters except the M/L ratios and the value of $`M_{MDO}`$, which must be derived through the kinematics.

## 4 Comparison between model and data

### 4.1 Photometry

Seifert and Scorza \[Seifert & Scorza, 1996\] have performed detailed CCD photometry in the R-band for a sample of 16 early-type disc galaxies, including NGC 4350. For each galaxy, they determined the radial profiles for surface brightness and ellipticity, together with a bulge/disc decomposition without special assumptions on the radial density profiles of the two components. According to the authors, the disc of NGC 4350 extends up to the innermost regions of the galaxy and follows approximately an exponential law; the spherical component dominates both in the nucleus and in the outer parts, as indicated by the strong external decrease in the ellipticity profile (see Fig. 1).

In order to describe the photometry of this galaxy we have adopted a three-component model:

1. an almost edge-on exponential disc component;
2. a diffuse spheroidal component, with a deVaucouleur surface brightness profile, extending well beyond the disc itself, identified hereafter as “stellar halo”;
3. a second spheroidal component, very compact and with an exponential profile in the inner 2′′ (see Fig. 1), which we identify as “bulge”.

The parameters derived by performing a best fit to the photometric data are presented in Table 2, together with their statistical uncertainties.

The rapid increase in the ellipticity from very small values to a maximum of $`\epsilon 0.7`$ at $`r30^{\prime \prime }`$ (see Figure 1) and its slow decline in the outer parts can be explained if at least three components are used. The two “spheroidal” components may represent two physically different stellar systems, or, since the best-fit flattenings are very similar, a single, almost spherical component with a density profile not represented by the de Vaucoleur’s law (see discussion in the Section 5.2).

### 4.2 Kinematics

Fisher \[Fisher, 1997\] has published ground-based kinematics of 18 early-type galaxies, including NGC 4350. The data includes the stellar rotation curve, velocity dispersion profile and the line-of-sight velocity distribution described in terms of the Gauss-Hermite expansion series terms $`h_3`$ and $`h_4`$ \[Van Der Marel & Franx, 1993\]. Emission line spectroscopy reveals a disc of rapidly rotating gas within the inner 3′′, which appears kinematically decoupled from the stellar component. In fact, while the gas is likely to follow circular orbits, the stellar velocity is obtained by taking into account the asymmetric drift effect as

$$V_{\mathrm{rot}}^2=V_{\mathrm{circ}}^2\mathrm{\Delta }V_{\mathrm{asymdrift}}^2,$$
(1)
where the $`\mathrm{\Delta }V_{\mathrm{asymdrift}}^2`$ \[Binney & Tremaine, 1987\] is essentially a function of the velocity dispersion and is only slightly dependent on the stellar distribution. The data are shown in Figs. 2-3.

Most parameters of the model have been fixed by fitting the photometry; the kinematic data are fitted by varying only the $`M/L`$ ratios of the different stellar components and the value of the MDO mass.

A robust upper limit to the central mass of the MDO can be obtained by assuming that the gas follows a Keplerian rotation curve. After convolution with seeing and slit effects, we obtain $`M_{MDO}<1.510^9\mathrm{M}_{}`$. However, since part of the gravitational force is due to the diffuse stellar component, we allowed the value of the dark mass concentration to vary between zero and $`M_{max}=1.510^9\mathrm{M}_{}`$. The value of the $`M/L`$ ratios for the spheroidal components was allowed to vary from 1 to 10 times the corresponding value for the disc.

We integrated the Jeans equations as detailed in Pignatelli and Galletta \[Pignatelli & Galletta, 1999\] to reproduce the kinematic data (see Figs. 23). The best-fit stellar M/L ratios spheroidal components and $`M_{MDO}`$ are given in Table 3, together with their statistical uncertainties.

For the MDO model, the error bars were obtained by computing the reduced $`\chi ^2`$ for the whole grid of models, and rejecting the models with a reduced $`\chi ^2`$ greater than the 95% confidence level. For the non-MDO model, since the reduced $`\chi ^2`$ was very high for all of the models, we kept the models with a $`\chi ^2`$ greater than three times the minimum value.

From Figure 2 it is apparent that within 2.5 kpc the galaxy can be divided into 3 different regions:

1. an inner region ($`r<120\mathrm{pc}`$) which features a sharp increase in both the stellar and gas rotation curve. This implies that this region is dynamically dominated by the presence of the central dark massive object, which also determines the central cusp in the velocity dispersion profile.
2. an intermediate region ($`120\mathrm{pc}<r<700\mathrm{pc}`$) which is bulge-dominated. In this dynamically hot region the asymmetric drift effect dominates the stellar rotation curve, as shown by the large difference ($`100`$ km/sec, i.e. a factor of more than 2) between the gas and the stellar velocities. The stellar rotational velocity reaches a plateau at about 50% of the circular velocity.
3. an outer region ($`r>700`$ pc) which is disc dominated. Here the stellar rotational velocity rises again, while the asymmetric drift effect plays a minor role. There is a probable flex point at $`r900\mathrm{pc}`$ in the stellar velocity dispersion profile, as expected from the superposition of bulge and disc populations with different kinematical behaviour but similar masses.

Remarkably, these kinematic features match exactly those expected from photometric decomposition. This is not trivial: it implies that inside 2 kpc the light traces the mass, thus ruling out the possibility of a sizable presence of dark matter.

It is worthwhile to discuss in detail the differences between the best-fit MDO and non-MDO models in Fig. 2-3.

First, under the assumption of M/L ratios constant with radius for each component, the M/L values found in the two cases are similar (see Table 3) within the error bars given by the fit. This reflects the fact that in both cases the kinematics beyond $`r=500`$ pc severely constrains all the parameters of the luminous matter in both cases.

The different panels of Fig. 2 show that the presence of the central massive object affects the different kinematical profiles up to different radii:

* The velocity dispersion profile is affected inside a “sphere of influence” of radius $`r_{\mathrm{BH}}=GM_{BH}/\sigma _0^2`$. This is the radius at which the black hole is expected to increase the velocity dispersion by a factor $`\sqrt{2}`$. For the observed value of $`\sigma _0`$ and the inferred value of $`M_{BH}`$ shown in Table 3, we expect $`r_{\mathrm{BH}}`$ to be about 70 pc, which is similar to what we see in Fig. 2b.
* While the velocity dispersion depends on the whole mass distribution, the circular velocity is only sensitive to the inner mass. The “radius of influence” in this case is the radius at which the stellar mass equals the MDO mass, and corresponds to about 200 pc, as can be seen in Fig. 4. At this radius the circular velocities of the MDO and non-MDO model differ by a factor $`\sqrt{2}`$, as shown in Fig. 2a. Beyond $`r=300`$ pc part of these differences is due to the different stellar M/L ratios (see Table 3).
* The differences between the two models in the circular velocity are strongly amplified in the stellar rotation curve. For instance, at $`r=300`$ pc, the MDO and non-MDO models have respective circular velocities of about 200 and 180 km/sec. Their asymmetric drift corrections $`\mathrm{\Delta }V_{asymdrift}`$ account respectively for about 185 and 178 km/sec. If the rotational velocities are computed using Eq. (1), these small differences are magnified as shown in Fig. 2.
* Finally, the MDO affects the $`h_3`$ moment of the line-of-sight velocity distribution up to a similar radius ($`r300`$ pc). The $`h_3`$ signature, together with the gas rotation curve, are of great help in constraining the orbital anisotropies because they rule out strongly radial orbits in the inner part of the galaxy.

## 5 Discussion

The photometric and kinematic data along both the major and minor axes have been explained through the superposition of different components: an inner MDO of mass $`4.99.710^8\mathrm{M}_{}`$, and three stellar components described in Table 3, with radial mass profiles $`M(r)`$ illustrated in Fig. 4. Each component is discussed separately hereafter.

### 5.1 The Massive Dark Object

The rotational velocities of both gas and stars are known to be much more efficient in constraining the mass of the central MDO than the velocity dispersion. Models without a central black hole fail to reproduce the shape of the inner rotation curve (see dot-dashed line in Fig. 2), unless unreasonable values of the bulge mass-to-light ratio are assumed which, however, would imply velocity dispersions much larger than those observed. In the inner kpc, the reduced chi-square is $`\chi 1.77`$ for the best-fit model with MDO, and $`\chi 100`$ for the model without MDO.

On the other hand, the errors given in Table 3 are just statistical errors. We must consider also possible systematic errors related to the assumptions used in the model.

The main concern is related to different hypotheses on the phase-space distribution function of the stellar component. So far, the model we presented is axisymmetric, with an isotropic velocity distribution. Such a model is associated with a distribution function which only depends on the two classical integrals of motion, i.e. energy and vertical angular momentum: $`f=f(E,L_z)`$. However, strong radial anisotropy in the centre of the galaxy results in a high velocity dispersions, mimicking the presence of a MDO \[Gebhardt et al., 2000b\].

For this specific galaxy, significant anisotropies in the velocity distribution would certainly raise the central velocity dispersion of the non-MDO model up to the observed value, but: (i) the gas rotational velocity, which is unaffected by the isotropic hypothesis, would be too low with respect to the observations; (ii) the stellar rotational velocity would decrease, moving away from the observations; (iii) The radial orbits in the central bin wound increase the $`h_4`$ parameter, in contrast with that suggested by the data. Thus, in this galaxy the hypothesis of radial orbits can not reduce the estimated MDO mass.

In principle, we cannot exclude the possibility that, inside the innermost observed kinematical point, the $`M/L`$ ratio of the stellar component is rising sharply enough to mimic the presence of a massive dark object. However, the innermost observed kinematical point is at $`R_{\mathrm{inner}}0.^{\prime \prime }6=66`$ pc, and the data requires a dynamical mass inside this point of $`1.110^9\mathrm{M}_{}`$, which, compared with the observed photometry, implies an $`M/L28`$ in this region, much higher than the value $`M/L11.5`$ found by Loyer et al. \[Loyer et al., 1998\]. Such a high mass-to-light ratio seems unlikely for any given choice of stellar population \[Worthey, 1994\]. Adopting an extreme $`M/L12`$ for the innermost region would only reduce the best-fit $`M_{MDO}`$ to $`510^8\mathrm{M}_{}`$, and the lower limit to $`2.510^8\mathrm{M}_{}`$.

In addition, we have not forced the whole galaxy to have the same stellar mass-to-light ratio. Instead, we allowed different M/L ratios for different components, although the best model fit suggests similar values for the bulge and stellar halo. This seems a reasonable hypothesis because it links every dynamical component to a given star formation history. The M/L ratio of our global stellar component increases with decreasing radius.

Finally, the hypothesis of constant flattening for each photometric component is also a possible source of systematic errors. Because of this assumption, we obtained a photometric decomposition with small statistical errors (see Table 2), despite the large seeing (about $`2.^{\prime \prime }5`$) of the ground-based observations. If we relax this hypothesis, then it is possible that the stellar component becomes flatter inside the seeing radius, contributing to the rotation shown in Fig. 2 and reducing the need for a central MDO.

We can not reproduce this kind of behaviour in a self-consistent way with our model. We can, however, give an estimate of the systematic errors involved, evaluating a set of models with different ellipticities for the bulge component, and trying to reproduce the stellar $`V`$ and $`\sigma `$ profile only in the inner $`2^{\prime \prime }`$. In order to fit the inner rotation curve without MDO, all the mass inside 2” must flattens to $`ϵ>0.3`$. On the other hand with $`ϵ=0.3`$, the central velocity dispersion falls below the predictions for the no MDO case with $`ϵ=0`$ and does not match the observations (cfr. Fig. 2). Under the asssumptions of $`M/L=12`$ for the bulge and $`ϵ0.2`$ within 2.5”, both the inner rotation velocity and dispersion velocity can be fitted within the error bars, if a central dark object with $`M_{MDO}1.510^8`$ is present.

Taking into account all the above listed source of uncertainties, the dark object mass falls in the range $`1.5<M_{MDO}<9.7\times 10^8`$, implying $`2<\mathrm{log}(M_{MDO}/M_{\mathrm{bulge}})<1.1`$. This wide range is substantially due to the poor resolution of the available data.

We can now locate NGC 4350 in the $`\sigma _eM_{MDO}`$ plane. Following the same prescription as in Gebhardt et al. \[Gebhardt et al., 2000a\], we computed for NGC 4350 a luminosity-weighted $`\sigma _e=`$180 km/s inside $`R_e`$. The relationship found by Gebhardt et al. \[Gebhardt et al., 2000a\] would predict for this value $`6.5\times 10^7M_{MDO}9.7\times 10^7`$. Although our best estimate is a factor of 10 larger than the value expected on the basis of $`\sigma _eM_{MDO}`$ relationship, nevertheless our lower limit is quite close to the expected range. In this context it is worth noticing that NGC 4350 was selected for our analysis on the basis of the high velocity rotation of its nuclear gas.

It is interesting to compare our results with those given in Loyer et al. \[Loyer et al., 1998\]. Adopting a single $`M/L`$ ratio of 7 for the whole stellar population, they found that the inner kinematics required a central point mass of $`M=810^8\mathrm{M}_{}`$, a result that agrees very well with our value of $`M_{MDO}=7.310^8\mathrm{M}_{}`$, despite the difference in the methods adopted. However, the evidence for a MDO was marginal. The difference between our results and those of Loyer et al. \[Loyer et al., 1998\] is due to the different dataset adopted: in particular, the fact that we included both the gas and star kinematics, and especially the $`h_3`$ and $`h_4`$ profiles, dramatically increases the constraints we can put on the $`M_{MDO}`$. This is especially true in the inner $`5^{\prime \prime }`$, where the shape of the line-of-sight velocity distribution is strongly non-gaussian (see Fig. 2), corroborating the conclusion that the search for an MDO is much more effective if the analysis of the higher orders of the line-of-sight velocity distribution is included \[Cretton & Van Den Bosch, 1999\].

### 5.2 The stellar component

The photometry of this galaxy can not be described by a simple superposition of a deVaucouleur spheroid and an exponential disc. The addition of a third spheroidal component is required. However, the fact that the mass-to-light ratios that reproduce the kinematical data for the two spheroidal components are similar suggests that there is a single, almost spherical stellar population; its brightness profile follows the deVaucouleurs law only up to the inner $`600`$ pc, and then starts to diverge towards a much steeper inner surface brightness profile. This behaviour agrees with recent HST high resolution photometric data \[Lauer et al., 1995\] showing that many ellipticals and bulges do have inner cusps steeper than expected from the $`r^{1/4}`$ law, with a luminosity density profile $`I(r)r^\gamma `$, with $`\gamma 1`$ for 5 pc $`<r<`$ 1 kpc. In addition, Faber et al. \[Faber et al., 1997\] have shown that this behaviour is more evident in rapidly rotating, disky bulges such as the one in NGC 4350.

A possible relation between the presence of a central BH and the inner surface brightness profile has been extensively investigated by several authors \[Young, 1980, Van Der Marel, 1999\] in the framework of adiabatic black hole growth. The effect on the photometry, however, can only be seen in the “sphere of influence” of radius $`r_{\mathrm{BH}}=GM_{BH}/\sigma _0^2`$, that we showed to be about 70 pc, which is less than $`1^{\prime \prime }`$ at Virgo distance. Our poor angular resolution did not allow us to check for this effect.

It is noteworthy that the mass-to-light ratio obtained for the spheroidal component ($`(M/L)_{\mathrm{sph}}=6.6\pm 0.7`$) is in good agreement with the relation by van der Marel \[Van Der Marel, 1991\], which yields $`(M/L)_{sph}=4.8\pm 1.5`$ for a galaxy of this luminosity. At the same time, the value we found for the disc ($`(M/L)_D=3.3\pm 0.3`$) is in agreement with Salucci & Persic \[Salucci & Persic, 1999\], that give $`(M/L)_D2.5\pm 0.5`$ at this luminosity.

We expect this difference in the $`M/L`$ ratio of the two components to be visible in the colour distribution of the galaxy. There is indeed evidence for a colour gradient, going from $`(BV)=1.1`$ in the inner, bulge-dominated region, to a $`(BV)0.84`$ in the intermediate region \[Prugniel & Heraudeau, 1998\], which qualitatively agrees with our results.

### 5.3 The dark matter halo

In the previous sections, we purposely limited ourselves to the inner regions of the galaxy ($`r2R_\mathrm{d}`$), since here the diffuse dark matter component is clearly not required by the data.

A complete and detailed investigation of the dark matter distribution in NGC 4350 is beyond the scope of this paper. Nevertheless, under the hypotheses described above, it is possible to derive a preliminary estimate on the mass and distribution of dark matter needed to explain the kinematical data in the outer regions.

The observed velocity \[Fisher, 1997\] is nearly circular and almost flat in the range $`1.8r3.5`$ kpc. It can be represented by a linear law $`V(R)=(175\pm 5)+(3.6\pm 1.2)r`$ , where $`r`$ is expressed in kpc e $`V`$ in km/sec. With the stellar distribution we derived in Table 3, this implies that within the last observed kinematical point $`R_{\mathrm{last}}3.5`$ kpc the dark matter amounts to $`M_{DM}=1.210^{10}\mathrm{M}_{}`$, which is 30% of the total mass inside this point. The DM density should equal that of the luminous matter at $`R3`$ kpc, so that, as observed in spiral galaxies \[Salucci & Persic, 1999\], in the inner regions the light traces the dynamic mass.

## 6 Conclusions

From the photometric and kinematic data available in the literature, we inferred the mass distribution for the S0 galaxy NGC 4350. The data used to constrain the model include: R-band photometry, rotational velocity of gas and stars and velocity dispersion profiles along both the major and minor axis, and the $`h_3`$ and $`h_4`$ profiles, for a total number of 280 data points. Our results can be summarized as follow:

An MDO of $`M1.59.710^8\mathrm{M}_{}`$ is located at the centre of the galaxy. A lower value for the central mass is possible if we allow for a very sharp increase of the anisotropy in the velocity distribution. However, this could be obtained only by neglecting the information content in the gas kinematics and the $`h_3`$ and $`h_4`$ parameters profiles.

This galaxy falls in the upper envelope of the $`M_{bulge}M_{BH}`$ or $`\sigma _eM_{BH}`$ relations known so far. This is expected, given that it has been selected for the very fast rotation of its nuclear disc.

The estimated stellar $`M/L`$ ratios ($`6.6`$ for the spheroid and $`3.3`$ for the disc) are in agreement with the average values usually found for these components. In order to explain the mass concentration in the centre of NGC 4350, the stellar $`M/L`$ ratio has to increase in the innermost 60 pc from the average value of 6.6 to $`28`$. Such a high value is, however, ruled out by the comparison between the observed colours and synthetic stellar population models.

Within the hypothesis of the model, the kinematical data between 2.5 and 3.5 kpc imply that the DM density equalizes that of the luminous matter at $`R3`$ kpc, and that the dark matter mass is 30% of the total within $`r=3.5`$ kpc.

Acknowledgements. We thank the referee, Dr. K. Gebhardt, for helpful comments and suggestions that greatly improved the quality of the paper.


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# Power-laws in economy and finance: some ideas from physics

## 1 Introduction

Physicists are often fascinated by power-laws. The reason for this is that complex, collective phenomenon do give rise to power-laws which are universal, that is to a large degree independent of the microscopic details of the phenomenon. These power-laws emerge from collective action and transcends individual specificities. As such, they are unforgeable signatures of a collective mechanism. Examples in the physics literature are numerous. A well known example is that of phase transitions, where a system evolves from a disordered state to an ordered state: many observables behave as universal power laws in the vicinity of the transition point . This is related to an important property of power-laws, namely scale invariance:111Power-law distributions are scale invariant in the sense that the relative probability to observe an event of a given size and an event ten times larger is independent of the reference scale. the characteristic length scale of a physical system at its critical point is infinite, leading to self-similar, scale-free fluctuations. Another example is fluid turbulence, where the statistics of the velocity field has scale invariant properties, to a large extent independent of the nature of the fluid, of the power injected, etc. .

Power-laws are also often observed in economic and financial data . Compared to physics, however, much less effort has been devoted to understand these power-laws in terms of ‘microscopic’ (i.e. agent based) models and to relate the value of the exponents to generic mechanisms. The aim of this contribution is to give a short review of diverse power-laws observed in economy/finance, and to discuss several simple models (most of them inspired from physics) which naturally lead to power-laws and could serve as a starting point for further developments. It should be stressed that none of the models presented here are intended to be fully realistic and complete, but are of pedagogical interest: they nicely illustrate how and when power-laws can arise. This paper is furthermore written in the spirit of a conference proceedings, and many rather speculative ideas are put forward to fuel further discussions.

## 2 Empirical power-laws: a short review

### 2.1 Distributional power-laws

The oldest and most famous power-law in economy is the Pareto distribution of wealth . The distribution of individual wealths $`P(W)`$ is often described, in its asymptotic tail, by a power law:

$$P(W)\frac{W_0^\mu }{W^{1+\mu }}WW_0,$$
(1)
where $`\mu `$ characterize the decay of the distribution for large $`W`$’s: the smaller the value of $`\mu `$, the slower the decay, and the larger the contrast between the richest and the poorest. More precisely, in a Pareto population of size $`N`$, the ratio of the largest wealth to the typical (e.g. median) wealth grows as $`N^{1/\mu }`$. In the case $`\mu <1`$, the average wealth diverges: this corresponds to an economy where a finite fraction of the total wealth is in the hands of a few individuals, even when $`N\mathrm{}`$. On the contrary, when $`\mu >1`$, the richest individual only holds a zero fraction of the total wealth (again in the limit $`N\mathrm{}`$). Empirically, the exponent $`\mu `$ is in the range $`1`$$`2`$. This Pareto tail also describes the distribution of income, the size of companies, of pension funds, etc. .

In financial markets, the distribution of the price increments $`\delta x_t=x(t^{})x(t)`$ over different time scales $`t^{}t`$ is important both for risk control purposes and for derivative pricing models . The availability of long series of high frequency data has motivated many empirical studies in the past few years. By pooling together the statistics of a thousand U.S. stocks, it is possible to study quite accurately the far tail of the distribution of intra-day price increments $`\delta x`$, which can be fitted as a power law :

$$P(\delta x)\frac{\delta x_0^\mu }{|\delta x|^{1+\mu }},$$
(2)
with $`\mu `$ in found to be close to $`3`$. Similar values have also been reported for Japanese stocks , German stocks , currencies , bond markets , and perhaps also the distribution of the (time dependent) daily volatility $`\sigma `$, defined as an average over high frequency returns  (although other works report a log-normal distribution ).222Note that the tails of a log-normal distribution can be fitted (over a restricted interval) by a power-law. Therefore it is not always easy to distinguish between true power-laws and effective power-laws. This suggests that the value of $`\mu `$ could be universal. Note however that the value of $`\mu `$ depends somewhat on the stock and on the period of time studied. For example, the value of $`\mu `$ for the S&P500 during the years 1991-1995 is found to be close to $`5`$. Furthermore, as the time lag used for the definition of $`\delta x`$ increases, the effective exponent describing the tail of the distribution increases as the distribution becomes more and more Gaussian like .

### 2.2 Temporal power-laws

Actually, the price increment at time $`t`$ can usefully be thought of as the product of a sign part $`ϵ_t`$ and an amplitude part (or volatility) $`\sigma _t`$:

$$\delta x_t=ϵ_t\times \sigma _t.$$
(3)
The random variable $`ϵ_t`$ has short ranged temporal correlations, extending over a few minutes or so on liquid markets . The volatility, on the contrary, has very long ranged correlations, which can be fitted as a power-law with a small exponent $`\nu `$ :

$$C_1(\tau )=\sigma _t\sigma _{t+\tau }\sigma _t^2\frac{c_1}{\tau ^\nu },$$
(4)
with $`\nu `$ approximately equal to $`0.1`$. This behaviour is, again, seen on many different types of markets, and quantifies the intermittent activity of these markets: volatility tends to cluster in bursts which persist over very different time scales, from minutes to months. A similar power-law behaviour of the temporal correlation of the volume of transactions (number of trades) is also observed . This is not surprising, since volatility and volume are strongly correlated. From a empirical point of view, the intermittent nature of the activity in financial markets is similar to the energy dissipation in a turbulent fluid .

In fact, the distribution of $`\mathrm{log}\sigma `$ is not far from being Gaussian . Therefore, it is natural to study the temporal correlation of $`\mathrm{log}\sigma `$ :

$$C_0(\tau )=\mathrm{log}\sigma _t\mathrm{log}\sigma _{t+\tau }\mathrm{log}\sigma _t^2.$$
(5)
This correlation is also found to decay very slowly with $`\tau `$. This decay can be fitted by a logarithm : $`C_0(\tau )=\lambda ^2\mathrm{log}(T/\tau )`$, with a rather small value of $`\lambda ^20.05`$. This, together with the assumption that $`\mathrm{log}\sigma `$ is exactly Gaussian, leads to a strict multifractal model for the price changes , in the sense that different moments of the price increments scale with different powers of time . Within this model, one finds :

$$|x(t+\tau )x(t)|^q\tau ^{\zeta _q}\zeta _q=\frac{q}{2}\left[1\lambda ^2(q2)\right],$$
(6)
for $`\tau T`$ and $`q\lambda ^2<1`$ (for higher values of $`q`$, the corresponding moment is divergent). It is easy to show that in this model, the exponent $`\nu `$ defined by Eq. (4) is equal to $`\lambda ^2`$. On the other hand, one can also fit $`C_0(\tau )`$ by a power-law with a small exponent, in which case the model would only be approximately multifractal, in the sense that the quantity $`|x(t+\tau )x(t)|^q`$ is the sum of different powers of $`\tau `$, which can also be fitted by an effective, $`q`$-dependent exponent $`\zeta _q<q/2`$ .

## 3 Simple models of wealth distribution

### 3.1 A model with trading and speculative investment

As a simple dynamical model of economy, one can consider a stochastic equation for the wealth $`W_i(t)`$ of the $`i^{th}`$ agent at time $`t`$, that takes into account the exchange of wealth between individuals through trading, and is consistent with the basic symmetry of the problem under a change of monetary units. Since the unit of money is arbitrary, one indeed expects that the equation governing the evolution of wealth should be invariant when all $`W_i`$’s are multiplied by a common (arbitrary) factor. A rather general class of equation which has this property is the following :

$$\frac{dW_i}{dt}=\eta _i(t)W_i+\underset{j(i)}{}J_{ij}W_j\underset{j(i)}{}J_{ji}W_i,$$
(7)
where $`\eta _i(t)`$ is a Gaussian random variable of mean $`m`$ and variance $`2\sigma ^2`$, which describes the spontaneous growth or decrease of wealth due to investment in stock markets, housing, etc. The term involving the (asymmetric) matrix $`J_{ij}`$ describes the amount of money that agent $`j`$ spends buying the production of agent $`i`$. We assume that this production is consumable, and therefore must not be counted as part of the wealth of $`i`$ once it is bought. The equation (7) is obviously invariant under the scale transformation $`W_i\lambda W_i`$.

The simplest trading network one can think of is when all agents exchange with all others at the same rate, i.e $`J_{ij}J/N`$ for all $`ij`$. Here, $`N`$ is the total number of agents, and the scaling $`J/N`$ is needed to make the limit $`N\mathrm{}`$ well defined. In this case, the equation for $`W_i(t)`$ becomes:

$$\frac{dW_i}{dt}=\eta _i(t)W_i+J(\overline{W}W_i),$$
(8)
where $`\overline{W}=N^1_iW_i`$ is the average overall wealth. This is called, in the physics language, a ‘mean-field’ model since all agents feel the very same influence of their environment. It is useful to rewrite eq. (8) in terms of the normalised wealths $`w_iW_i/\overline{W}`$. This leads to:

$$\frac{dw_i}{dt}=(\eta _i(t)m\sigma ^2)w_i+J(1w_i),$$
(9)
to which one can associate the following Fokker-Planck equation for the evolution of the density of wealth $`P(w,t)`$:

$$\frac{P}{t}=\frac{[J(w1)+\sigma ^2w]P}{w}+\sigma ^2\frac{}{w}\left[w\frac{wP}{w}\right].$$
(10)
The equilibrium, long time solution of this equation is easily shown to be:

$$P_{eq}(w)=\frac{(\mu 1)^\mu }{\mathrm{\Gamma }[\mu ]}\frac{e^{\frac{\mu 1}{w}}}{w^{1+\mu }}\mu 1+\frac{J}{\sigma ^2}.$$
(11)
Therefore, one finds in this model that the distribution of wealth indeed exhibits a Pareto power-law tail for large $`w`$’s. Interestingly, however, the value of the exponent $`\mu `$ is not universal, and depends on the parameter of the model ($`J`$ and $`\sigma ^2`$, but not on the average growth rate $`m`$). In agreement with intuition, the exponent $`\mu `$ grows (corresponding to a narrower distribution), when exchange between agents is more active (i.e. when $`J`$ increases), and also when the success in individual investment strategies is more narrowly distributed (i.e. when $`\sigma ^2`$ decreases). In this model, the exponent $`\mu `$ is always found to be larger than one. This means that the wealth is not too unevenly distributed within the population.

Let us now describe more realistic trading network, where the number of economic neighbours to a given individual is finite. We will assume that the matrix $`J_{ij}`$ is still symmetrical, and is either equal to $`J`$ (if $`i`$ and $`j`$ trade), or equal to $`0`$. A reasonable assumption is that the graph describing the connectivity of the population is completely random, i.e. that two points are neighbours with probability $`c/N`$ and disconnected with probability $`1c/N`$. In such a graph, the average number of neighbours is equal to $`c`$. We have performed some numerical simulations of Eq. (7) for $`c=4`$ and have found that the wealth distribution still has a power-law tail, with an exponent $`\mu `$ which only depends on the ratio $`J/\sigma ^2`$. However, one finds that the exponent $`\mu `$ can now be smaller than one for sufficiently small values of $`J/\sigma ^2`$ . In this model, one therefore expects ‘wealth condensation’ when the exchange rate is too small, in the sense that a finite fraction of the total wealth is held by only a few individuals.

Although not very realistic, one could also think that the individuals are located on the nodes of a d-dimensional hyper-cubic lattice, trading with their neighbours up to a finite distance. In this case, one knows that for $`d>2`$ there exists again a phase transition between a ‘social’ economy where $`\mu >1`$ and a rich dominated phase $`\mu <1`$. On the other hand, for $`d2`$, and for large populations, one is always in the extreme case where $`\mu 0`$ at large times. In the case $`d=1`$, i.e. operators organized along a chain-like structure (as a simple model of intermediaries), one can actually compute exactly the distribution of wealth . One finds for example that the ratio of the maximum wealth to the typical (e.g. median) wealth behaves as $`\mathrm{exp}\sqrt{N}`$, where $`N`$ is the size of the population, instead of $`N^{1/\mu }`$ in the case of a Pareto distribution with $`\mu >0`$.

The conclusion of the above results is that the distribution of wealth tends to be very broadly distributed when exchanges are limited, either in amplitude (i.e. $`J`$ too small compared to $`\sigma ^2`$) or topologically (a s in the above chain structure). Favoring exchanges (in particular with distant neighbours) seems to be an efficient way to reduce inequalities.

### 3.2 Two related models

Let us now interpret $`W_i`$ as the size of a company. The growth of this company can take place either from internal growth, depending on its success or failure. This leads to a term $`\eta _i(t)W_i`$ much as above. Another possibility is merging with another company. If the merging process between two companies is completely random and takes place at a rate $`\mathrm{\Gamma }`$ per unit time, then the model is exactly the same as the one considered by Derrida and Spohn  in the context of ‘directed polymers in random media’, and bears strong similarities with the model discussed in the previous section. One again finds that the distribution of $`W`$’s is a power-law with a non universal exponent, which depends on the values of $`\mathrm{\Gamma }`$ and $`\sigma ^2`$, and can be smaller than one.333In the language of disordered systems, this corresponds to the ‘glassy’ phase of the directed polymer, where the partition function is dominated by a few paths only.

One can also consider a model where companies grow at a random rate $`\eta `$, but may also suddenly die at a rate $`\mathrm{\Gamma }^{}`$ per unit time, and be replaced by a new (small) company. There again, one finds a stationary Pareto distribution, with a non universal exponent which depends continuously on $`m`$, $`\sigma `$ and $`\mathrm{\Gamma }^{}`$.

## 4 Simple models for herding and copy-cats

We now turn to simple models for thick tails in the distribution of price increments in financial markets. An intuitive explanation is herding: if a large number of agents acting on markets coordinate their action, the price change is likely to be huge due to a large unbalance between buy and sell orders . However, this coordination can result from two rather different mechanisms.

* One is the feedback of past price changes onto themselves, which we will discuss in the following section. Since all agents are influenced by the very same price changes, this can induce non trivial collective behaviour: for example, an accidental price drop can trigger large sell orders, which lead to further downward moves.
* The second is direct influence between the traders, through exchange of information that leads to ‘clusters’ of agents sharing the same decision to buy, sell, or be inactive at any given instant of time.

### 4.1 Herding and percolation

A simple model of how herding affects the price fluctuations was proposed in . It assumes that the price increment $`\delta x`$ depends linearly on the instantaneous offset between supply and demand . More precisely, if each operator in the market $`i`$ wants to buy or sell a certain fixed quantity of the financial asset, one has :444This can alternatively be written for the relative price increment $`\delta x/x`$, which is more adapted to describe long time scales. On short time scales, however, an additive model is preferable. See the discussion in .

$$\delta x=\frac{1}{\lambda }\underset{i}{}\phi _i,$$
(12)
where $`\phi _i`$ can take the values $`\mathrm{\hspace{0.17em}1},\mathrm{\hspace{0.17em}0}`$ or $`+\mathrm{\hspace{0.17em}1}`$, depending on whether the operator $`i`$ is selling, inactive, or buying, and $`\lambda `$ is a measure of the market depth. Note that the linearity of this relation, even for small arguments, has been questioned by Zhang . Suppose now that the operators interact among themselves in an heterogeneous manner: with a small probability $`c/N`$ (where $`N`$ is the total number of operators on the market), two operators $`i`$ and $`j`$ are ‘connected’, and with probability $`1c/N`$, they ignore each other. The factor $`1/N`$ means that on average, the number of operator connected to any particular one is equal to $`c`$ (the resulting graph is precisely the same as the random trading graph of Section 3.1). Suppose finally that if two operators are connected, they come to agree on the strategy they should follow, i.e. $`\phi _i=\phi _j`$.

It is easy to understand that the population of operators clusters into groups sharing the same opinion. These clusters are defined such that there exists a connection between any two operators belonging to this cluster, although the connection can be indirect and follow a certain ‘path’ between operators. These clusters do not have all the same size, i.e. do not contain the same number of operators. If the size of cluster $`𝒞`$ is called $`S(𝒞)`$, one can write:

$$\delta x=\frac{1}{\lambda }\underset{𝒞}{}S(𝒞)\phi (𝒞),$$
(13)
where $`\phi (𝒞)`$ is the common opinion of all operators belonging to $`𝒞`$. The statistics of the price increments $`\delta x`$ therefore reduces to the statistics of the size of clusters, a classical problem in percolation theory . One finds that as long as $`c<1`$ (less than one ‘neighbour’ on average with whom one can exchange information), then all $`S(𝒞)`$’s are small compared to the total number of traders $`N`$. More precisely, the distribution of cluster sizes takes the following form in the limit where $`1c=ϵ1`$:

$$P(S)_{S1}\frac{1}{S^{5/2}}\mathrm{exp}ϵ^2SSN.$$
(14)
When $`c=1`$ (percolation threshold), the distribution becomes a pure power-law with an exponent $`\mu =3/2`$, and the Central Limit Theorem tells us that in this case, the distribution of the price increments $`\delta x`$ is precisely a pure symmetrical Lévy distribution of index $`\mu =3/2`$  (assuming that $`\phi =\pm \mathrm{\hspace{0.17em}1}`$ play identical roles, that is if there is no global bias pushing the price up or down). If $`c<1`$, on the other hand, one finds that the Lévy distribution is truncated exponentially, leading to a larger effective tail exponent $`\mu `$ . If $`c>1`$, a finite fraction of the $`N`$ traders have the same opinion: this leads to a crash.

### 4.2 Avalanches of opinion changes

The above model is interesting but has one major drawback: one has to assume that the parameter $`c`$ is smaller than one, but relatively close to one such that Eq. (14) is valid, and non trivial statistics follows. One should thus explain why the value of $`c`$ spontaneously stabilises in the neighbourhood of the critical value $`c=1`$. Furthermore, this model is purely static, and does not specify how the above clusters evolve with time. As such, it cannot address the problem of volatility clustering. Several extensions of this simple model have been proposed , in particular to increase the value of $`\mu `$ from $`\mu =3/2`$ to $`\mu 3`$ and to account for volatility clustering.

One particularly interesting model is inspired by the recent work of Dahmen and Sethna , that describes the behaviour of random magnets in a time dependent magnetic field. Transposed to the present problem (as first suggested in ) , this model describes the collective behaviour of a set of traders exchanging information, but having all different a priori opinions. One trader can however change his mind and take the opinion of his neighbours if the coupling is strong, or if the strength of his a priori opinion is weak. More precisely, the opinion $`\phi _i(t)`$ of agent $`i`$ at time $`t`$ is determined as:

$$\phi _i(t)=\text{sign}\left(h_i(t)+\underset{j=1}{\overset{N}{}}J_{ij}\phi _j(t)\right),$$
(15)
where $`J_{ij}`$ is a connectivity matrix describing how strongly agent $`j`$ affects agent $`i`$, and $`h_i(t)`$ describes the a priori opinion of agent $`i`$: $`h_i>0`$ means a propensity to buy, $`h_i<0`$ a propensity to sell. We assume that $`h_i`$ is a random variable with a time dependent mean $`\overline{h}(t)`$ and root mean square $`\mathrm{\Delta }`$. The quantity $`\overline{h}(t)`$ represents for example confidence in long term economy growth ($`\overline{h}(t)>0`$), or fear of recession ($`\overline{h}(t)<0`$, leading to a non zero average pessimism or optimism. Suppose that one starts at $`t=0`$ from a ‘euphoric’ state, where $`\overline{h}\mathrm{\Delta },J`$, such that $`\phi _i=1`$ for all $`i`$’s.555Here $`J`$ denotes the order of magnitude of $`_jJ_{ij}`$ Now, confidence is decreased progressively. How will sell orders appear ?

Interestingly, one finds that for small enough influence (or strong heterogeneities of agents’ anticipations), i.e. for $`J\mathrm{\Delta }`$, the average opinion $`O(t)=_i\phi _i(t)/N`$ evolves continuously from $`O(t=0))=+1`$ to $`O(t\mathrm{})=1`$. The situation changes when imitation is stronger since a discontinuity then appears in $`O(t)`$ around a ‘crash’ time $`t_c`$, when a finite fraction of the population simultaneously change opinion. The gap $`O(t_c^{})O(t_c^+)`$ opens continuously as $`J`$ crosses a critical value $`J_c(\mathrm{\Delta })`$ . For $`J`$ close to $`J_c`$, one finds that the sell orders again organise as avalanches of various sizes, distributed as a power-law with an exponential cut-off. In the ‘mean-field’ case where $`J_{ij}J/N`$ for all $`ij`$, one finds $`\mu =5/4`$. Note that in this case, the value of the exponent $`\mu `$ is universal, and does not depend, for example, on the shape of the distribution of the $`h_i`$’s, but only on some global properties of the connectivity matrix $`J_{ij}`$.

A slowly oscillating $`\overline{h}(t)`$ can therefore lead to a succession of bull and bear markets, with a strongly non Gaussian, intermittent behaviour, since most of the activity is concentrated around the crash times $`t_c`$. Some modifications of this model are however needed to account for the empirical value $`\mu 3`$ observed on the distribution of price increments (see the discussion in ).

Note that the same model can be applied to other interesting situations, for example to describe how applause end in a concert hall  (here, $`\phi =\pm 1`$ describes, respectively, a clapping and a quiet person, and $`O(t)`$ is the total clapping activity). Clapping can end abruptly (as often observed, at least by the present author) when imitation is strong, or smoothly when many fans are present in the audience. A static version of the same model has been proposed to describe rational group decision making .

## 5 Models of feedback effects on price fluctuations

### 5.1 Risk-aversion induced crashes

The above average ‘stimulus’ $`\overline{h}(t)`$ may also strongly depend on the past behaviour of the price itself. For example, past positive trends are, for many investors, incentives to buy, and vice-versa. Actually, for a given trend amplitude, price drops tend to feedback more strongly on investors’ behaviour than price rises. Risk-aversion creates an asymmetry between positive and negative price changes . This is reflected by option markets, and pushes the price of out-of-the-money puts up.

Similarly, past periods of high volatility increases the risk of investing in stocks, and usual portfolio theories then suggest that sell orders should follow. A simple mathematical transcription of these effects is to write Eq. (12) in a linearized, continuous time form:666In the following, the herding effects described by $`J_{ij}`$ are neglected, or more precisely, only their average effect encoded by $`\overline{h}`$ is taken into account.

$$\frac{dx}{dt}u=\frac{1}{\lambda }\overline{h}(t),$$
(16)
and write a dynamical equation for $`\overline{h}(t)`$ which encodes the above feedback effects :

$$\frac{d\overline{h}}{dt}=aubu^2c\overline{h}+\eta (t),$$
(17)
where $`a`$ describes trends following effects, $`b`$ risk aversion effects (breaking the $`uu`$ symmetry), $`c`$ is a mean reverting term which arises from market clearing mechanisms, and $`\eta `$ is a noise term representing random external news . Eliminating $`\overline{h}`$ from the above equations leads to:

$$\frac{du}{dt}=\gamma u\beta u^2+\frac{1}{\lambda }\eta (t)\frac{V}{u}+\frac{1}{\lambda }\eta (t)$$
(18)
where $`\gamma =ca/\lambda `$ and $`\beta =b/\lambda `$. Equation (18) represents the evolution of the position $`u`$ of a viscous fictitious particle in a ‘potential’ $`V(u)=\gamma u^2/2+\beta u^3/3`$. If trend following effects are not too strong, $`\gamma `$ is positive and $`V(u)`$ has a local minimum for $`u=0`$, and a local maximum for $`u^{}=\gamma /\beta `$, beyond which the potential plummets to $`\mathrm{}`$.777If $`\gamma `$ is negative, the minimum appears for a positive value of the return $`u^{}`$. This corresponds to a speculative bubble. See . A ‘potential barrier’ $`V^{}=\gamma u^2/6`$ separates the (meta-)stable region around $`u=0`$ from the unstable region. The nature of the motion of $`u`$ in such a potential is the following: starting at $`u=0`$, the particle has a random harmonic-like motion in the vicinity of $`u=0`$ until an ‘activated’ event (i.e. driven by the noise term) brings the particle near $`u^{}`$. Once this barrier is crossed, the fictitious particle reaches $`\mathrm{}`$ in finite time. In financial terms, the regime where $`u`$ oscillates around $`u=0`$ and where $`\beta `$ can be neglected, is the ‘normal’ fluctuation regime. This normal regime can however be interrupted by ‘crashes’, where the time derivative of the price becomes very large and negative, due to the risk aversion term $`b`$ which destabilizes the price by amplifying the sell orders. The interesting point is that these two regimes can be clearly separated since the average time $`t^{}`$ needed for such crashes to occur is exponentially large in $`V^{}`$ , and can thus appear only very rarely. A very long time scale is therefore naturally generated in this model.

Note that in this line of thought, a crash occurs because of an improbable succession of unfavorable events, and not due to a single large event in particular. Furthermore, there are no ‘precursors’ in this model: before $`u`$ has reached $`u^{}`$, it is impossible to decide whether it will do so or whether it will quietly come back in the ‘normal’ region $`u0`$. Solving the Fokker-Planck equation associated to the Langevin equation (18) leads to a stationary state with a power law tail for the distribution of $`u`$ (i.e. of the instantaneous price increment) decaying as $`u^2`$ for $`u\mathrm{}`$. More generally, if the risk aversion term took the form $`bu^{1+\mu }`$, the negative tail would decay as $`u^{1\mu }`$.

### 5.2 Dynamical volatility models

The simplest model that describes volatility feedback effects is to write an arch like equation , which relates today’s activity to a measure of yesterday’s activity, for example:

$$\sigma _k=\sigma _{k1}+K(\sigma _0\sigma _{k1})+g|\delta x_{k1}|,$$
(19)
where $`\sigma _0`$ is an average volatility level, $`K`$ a mean-reverting term, and $`g`$ describes how much yesterday’s observed price change affects the behaviour of traders today. Since $`|\delta x_{k1}|`$ is a noisy version of $`\sigma _{k1}`$, the above equation is, in the continuous time limit, a Langevin equation with multiplicative noise:

$$\frac{d\sigma }{dt}=K(\sigma _0\sigma )+g\sigma \eta (t),$$
(20)
which is, up to notation changes, exactly the same equation as (9) above. Therefore, the stationary distribution of the volatility in this model is again given by Eq. (11), with the tail exponent now given by $`\mu 1K/g^2`$: over-reactions to past informations (i.e. large values of $`g`$) decreases the tail exponent $`\mu `$. Therefore, one again finds a non universal exponent in this model, which is bequeathed to the distribution of price increments if one assumes that the ‘sign’ contribution to $`\delta x_k`$ (see Eq. (3)) has thin tails.

Note that the temporal correlations of the volatility $`\sigma `$ can be exactly calculated within this model , and is found to be exponentially decaying, at variance with the slow power-law (or logarithmic) decay observed empirically. Furthermore, the distribution (11) does not concur with the nearly log-normal distribution of the volatility that seems to hold empirically .

At this point, the slow decay of the volatility can be ascribed to two rather different mechanisms. One is the existence of traders with many different time horizons, as suggested in . If traders are affected not only by yesterday’s price change amplitude $`|\delta x_{k1}|`$, but also by price changes on coarser time scales $`|x_kx_{kp}|`$, then the correlation function is expected to be a sum of exponentials with decay rates given by $`p^1`$. Interestingly, if the different $`p`$’s are uniformly distributed on a log scale, the resulting sum of exponentials is to a good approximation decaying as a logarithm. More precisely:888This mechanism is well known in the physics of slow, glassy systems, where the relaxation times $`p`$ are the exponential of some local activation energy $`E`$. At low temperatures, any small dispersion of $`E`$ will generate a $`1/p`$ distribution for $`p`$ over a wide time interval, and eventually to a logarithmic relaxation.

$$C(\tau )=\frac{1}{\mathrm{log}(p_{\mathrm{max}}/p_{\mathrm{min}})}_{p_{\mathrm{min}}}^{p_{\mathrm{max}}}d(\mathrm{log}p)\mathrm{exp}(\tau /p)\frac{\mathrm{log}(p_{\mathrm{max}}/\tau )}{\mathrm{log}(p_{\mathrm{max}}/p_{\mathrm{min}})},$$
(21)
whenever $`p_{\mathrm{min}}\tau p_{\mathrm{max}}`$. Now, the human time scales are indeed in a natural pseudo-geometric progression: hour, day, week, month, trimester, year .

Yet, some recent numerical simulations of traders allowed to switch between different strategies (active/inactive, or chartist/fundamentalist) suggest strongly intermittent behaviour , and a slow decay of the volatility correlation function without the explicit existence of logarithmically distributed time scales. An intuitive, semi-analytical explanation of this numerical finding is however still lacking. Note that from a purely phenomenological point of view, one can define a model that assumes that the volatility today is the retarded result of past influences:

$$\sigma _k=\underset{p=0}{\overset{\mathrm{}}{}}M(p)\eta _{kp},$$
(22)
where the $`\eta `$’s are uncorrelated shocks and $`M(p)`$ a memory kernel describing how much the past is remembered. If one chooses a power-law decay for $`M(p)`$ with an exponent $`\alpha `$, then the decay of the correlation function of $`\sigma `$ is also a power-law with an exponent $`\nu `$ (defined in Eq. (4)) given by $`\nu =2\alpha 1`$. The value $`\nu =0`$ corresponds to a memory kernel decaying as $`1/\sqrt{p}`$, i.e., as the probability of not returning to the origin for a random walk of length $`p`$. Whether this is a mere coincidence is left for future investigations. Note however that a decomposition such as (22) naturally leads to a normal distribution for $`\sigma `$, very different from the empirical log-normal behaviour of the volatility. A consistent market model leading simultaneously to a nearly log-normal distribution and a nearly logarithmic (in time) decay of the volatility correlation remains to be built. In this respect, the cascade construction of Mandelbrot et al.  does indeed have these two properties exactly, but is non-causal (the volatility today depends on future events) and lacks an intuitive interpretation.

## 6 Concluding remarks

Many ideas have been presented in this rather hairy paper. Most of them will perhaps turn out to be wrong, but will hopefully motivate some further work to understand the origin of power-law distributions and power-law correlations in financial time series. From an empirical point of view, the exponents describing the tails of the price increments distribution and the decay of the volatility correlations are rather robust and suggest some kind of universality, probably related to the fact that all speculative markets obey common rules where simple human psychology (greed and fear) coupled to basic mechanisms of price formation ultimately lead to the emergence of scaling and power-laws. Still, many points remain obscure: we have seen above that models that appear naturally in the context of economy and finance contain multiplicative noise, which is a simple mechanism for power-law distributions (as emphasized in, e.g. ). However, these models generically lead to non universal exponents (as discussed above in the context of the Pareto tails) that depends continuously on the value of the parameters. Recent progress in the empirical study of the volatility (using, e.g., wavelets ) suggests that the volatility results from some sort of multiplicative cascade, as postulated in . A convincing ‘microscopic’ (i.e. trader based) model that explains this observation would at this stage be very valuable, and would shed light on the possible relevance of the pseudo geometric human time scales on the decay of the volatility correlations.

## Acknowledgments

I want to warmly thank all my collaborators for sharing with me their knowledge: P. Cizeau, R. Cont, I. Giardina, L. Laloux, A. Matacz, M. Mézard, M. Meyer and M. Potters. Several discussions with E. Bacry, R. da Silvera, M. Dacorogna, D. Farmer, T. Lux, R. Mantegna, J.F. Muzy, G. Stanley, D. Stauffer and S. Solomon have been very useful.