Hurst found that flooding exhibited a persistent pattern. Large floods were not only frequent, but came in clumps. They had a long memory. The Hurst coefficient summarises this behaviour in a single number. For example, a measured Hurst equal to 0.5 is consistent with the random walk model familiar from efficient markets theory. A Hurst coefficient above 0.5 implies fatter tails and longer memories. In his study, Smith finds that the Hurst coefficient among a selection of stocks has risen steadily above 0.5 since 2005. In other words, the advent of HFT has seen price dynamics mirror the fat-tailed persistence of the Nile flood plains. To illustrate, Chart 11 plots the path of three simulated price series with Hurst coefficients of 0.5, 0.7 and 0.9. A higher Hurst coefficient radically alters the probability of sharp dislocations in prices. It also prolongs these dislocations. Prices become de-anchored and drift; their variance grows over time and is unbounded. If this long-memory property of prices is emerging at ever-higher frequencies, it might provide an important clue to how HFT affects systemic risk. 4. A sketch model of market macrostructure  To see that, consider a sketch model of market-making. This builds on an analytical insight which is already more than 40 years old. It owes to the late Benoit Mandelbrot, FrenchAmerican mathematician and architect of fractal geometry. Mandelbrot found that a great many real-world topologies exhibited a fractal pattern. By this he meant that the basic pattern repeated itself, whatever the scale at which it was observed.

253-66. BIS Review 17/2005  5  Consequently, derivatives markets contribute to the predictability cash flows of economic agents and their profits or losses arising from risk or volatility by reducing excessive volatility in spot markets, on one hand, and by offering an opportunity to economic agents for risk management, on the other hand. In this way, fragilities in the firms sector arising from deteriorations in balance sheets are restored and the economy as a whole strengthens itself against shocks. At this stage, I would like to highlight one more point about the floating exchange rate regime. In Turkey, firms have to be cautious about imbalances in foreign exchange denominated assets and liabilities on their balance sheets. Under the floating exchange rate regime, firms with foreign currency-denominated income and domestic currency-denominated expenditure, or vice versa, should restore the imbalances on their balance sheets, in other words, eliminate the exchange rate risk they are faced with. In order to achieve this, firms should observe risk management principles and employ derivatives market instruments. Firms, especially production firms, can allocate more resources for production by reducing the financial risks on their balance sheets. This also makes an important contribution to enhancing the competitiveness of firms. As of 2003, 92 percent of world’s largest 500 non-financial firms are protected against risk through derivatives instruments and this further reinforces the importance of such instruments6. Moreover, I would like to point out that the benefits of derivatives instruments do not depend on the size of the firms they are used by.