Lognormally distributed share returns: Difference between revisions
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If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution. | If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution. | ||
Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns. | Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns. | ||
Revision as of 13:31, 6 May 2016
If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution.
Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns.
But the theoretically worst outcome for a share investor is to lose the whole of their investment - in other words a negative return of -100%.
It is not theoretically possible to suffer a return of worse than -100%.
Lognormal distributions - unlike normal distributions - also have a limited downside, so they do not suffer from this theoretical shortcoming.
