Statistics and Data

Analysis

Professor William Greene

Stern School of Business
Department of IOMS
Department of Economics
Statistics and Data Analysis

Part 11A – Lognormal

Random Walks
 Lognormal Random Walk

 The lognormal model

remedies some of the
shortcomings of the linear
(normal) model.
 Somewhat more realistic.
 Equally controversial.
 Description follows for
those interested.

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 30/46

Lognormal Variable
1  1  logx - μ  
2

f(x) = exp -   , 0 < x < + 

xσ 2π  2  σ  
Histogram of Wage
Lognormal
120 Loc 6.951

If the log of a variable has a normal

Scale 0.4384
N 595
100

80
distribution, then the variable has a
lognormal distribution.
Frequency

60

40 Mean =Exp[μ+σ2/2] >

20
Median = Exp[μ]
0
0 800 1600 2400 3200 4000 4800
Wage

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 31/46

Lognormality – Country Per Capita

Gross Domestic Product Data

Histogram of GDPC Histogram of logGDPC

Normal Normal
70 Mean 6609 16 Mean 8.248
StDev 7165 StDev 1.060

60 N 191 14 N 191

12
50
10
Frequency

Frequency
40
8
30
6
20
4

10 2

0 0
-6000 0 6000 12000 18000 24000 30000 6.4 7.2 8.0 8.8 9.6 10.4
GDPC logGDPC

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 32/46

Lognormality – Earnings in a
Large Cross Section
Histogram of Wage
Normal
120 Mean 1148
StDev 531.1
N 595
100

80
Histogram of LogWage
Frequency

Normal
60
80 Mean 6.951
StDev 0.4384
40 70 N 595

60
20
50

Frequency
0
0 800 1600 2400 3200 4000 4800 40
Wage
30

20

10

0
6.0 6.4 6.8 7.2 7.6 8.0 8.4
LogWage

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 33/46

Lognormal Variable Exhibits Skewness

Histogram of Wage
Lognormal
120 Loc 6.951
Scale 0.4384
N 595
100

80
Frequency

60 The mean is to the

right of the median.
40

20

0
0 800 1600 2400 3200 4000 4800
Wage

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 34/46

Lognormal Distribution for

Price Changes
 Math preliminaries:
 (Growth) If price is P0 at time 0 and the price grows by
100Δ% from period 0 to period 1, then the price at period
1 is P0(1 + Δ). For example, P0=40; Δ = 0.04 (4% per
period); P1 = P0(1 + 0.04).

 (Price ratio) If P1 = P0(1 + 0.04) then P1/P0 = (1 + 0.04).

 (Math fact) For smallish Δ, log(1 + Δ) ≈ Δ

Example, if Δ = 0.04, log(1 + 0.04) = 0.39221.

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 35/46

Collecting Math Facts

Pt
If Pt = Pt-1[1 + Δ ] then = [1 + Δ]
Pt-1
 Pt 
log   = log[1 + Δ ]
 Pt-1 
 Δ

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 36/46

Building a Model
Slightly change the assumptions. Suppose
Δ isn't a constant, but can be different each
period.
Pt
If Pt = Pt-1[1 + Δ t ] then = [1 + Δ t ]
Pt-1
 Pt 
log   = log[1 + Δ t ]
 Pt-1 
 Δt
I.e., prices change by different amounts in
different periods.
Marginal Plot of Listing vs IncomePC
Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 37/46

A Second Period
P1
If P1 = P0 [1 + Δ 1 ] then = [1 + Δ 1]
P0
Now, change for a second period
If P2 = P1[1 + Δ 2 ], then P2 =  P0 [1 + Δ 1]  [1 + Δ 2 ] so
P2
= [1 + Δ 1 ]  [1 + Δ 2 ]
P0
 P2 
log   = log[1 + Δ 1 ]+log[1 + Δ 2 ]
 P0 
 Δ1  Δ 2
Marginal Plot of Listing vs IncomePC
Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 38/46

What Does It Imply?

For T periods
P 

T
log  T  = log[1 + Δ 1 ]+log[1 + Δ 2 ]+...+log[1 + Δ T ]  Δt
 P0 
t=1

For T-1 periods

 PT-1 

T-1
log   = log[1 + Δ 1 ]+log[1 + Δ 2 ]+...+log[1 + Δ T-1]  Δt
P
 0 
t=1

By subtraction
 PT   PT-1 
  t=1 t  t=1 Δ t
T T-1
log    log   Δ 
 P0   P0 
= ΔT

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 39/46

Random Walk in Logs

By subtraction
P   PT-1 
  t=1 t  t=1 Δ t = Δ T
T T-1
log  T   log   Δ 
 P0   P0 
But
P   PT-1 
log  T   log    logPT  logP0  logPT 1  logP0
 P0   P0 
so,
logPT  logPT 1  Δ T
This is the same random walk we had before, but now
it is in logs, rather than in prices.
Marginal Plot of Listing vs IncomePC
Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 40/46

Lognormal Model for Prices

 PT 
log   = log[1 + Δ 1 ]+log[1 + Δ 2 ]+ ...+log[1 + Δ T ]
 P0 
 Δ 1  Δ 2  ...  Δ T
so,
logPT  logP0   t 1 Δ t
T

If the period to period changes Δ t are normally distributed with

mean  and standard deviation , then logPT has a normal
distribution with mean logP0 +T  and standard deviation  T.

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 41/46

Lognormal Random Walk

If
logPT  logP0   t 1 Δ t
T

Then

T

PT = P0 e t 1 t

which looks like the present value result, VT  V0 erT

for T periods and constant growth rate per period, r.
Marginal Plot of Listing vs IncomePC
Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 42/46

Application
 Suppose P0 = 40, μ=0 and σ=0.02. What is the probabiity that
P25, the price of the stock after 25 days, will exceed 45?
 logP25 has mean log40 + 25μ =log40 =3.6889 and standard
deviation σ√25 = 5(.02)=.1. It will be at least approximately
normally distributed.

 P[P25 > 45] = P[logP25 > log45] = P[logP25 > 3.8066]

 P[logP25 > 3.8066] =

P[(logP25-3.6889)/0.1 > (3.8066-3.6889)/0.1)]=

P[Z > 1.177] = P[Z < -1.177] = 0.119598

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 43/46

Prediction Interval
We are 95% certain that logP25 is in the interval

logP0 + μ25 - 1.96σ25 to logP0 + μ25 + 1.96σ25.

Continue to assume
μ=0 so μ25 = 25(0)=0 and σ=0.02 so σ25 = 0.02(√25)=0.1

Then, the interval is 3.6889 -1.96(0.1) to 3.6889 + 1.96(0.1)

or 3.4929 to 3.8849.

This means that we are 95% confident that P0 is in the range

e3.4929 = 32.88 and e3.8849 = 48.66

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 44/46

Observations - 1

 The lognormal model (lognormal

random walk) predicts that the price
will always take the form PT = P0eΣΔ t

 This will always be positive, so this

overcomes the problem of the first
model we looked at.

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 45/46

Observations - 2
 The lognormal model has a quirk of its own. Note that
when we formed the prediction interval for P25 based on
P0 = 40, the interval is [32.88,48.66] which has center at
40.77 > 40, even though μ = 0. It looks like free money.
 Why does this happen? A feature of the lognormal
model is that E[PT] = P0exp(μT + ½σT2) which is greater
than P0 even if μ = 0.
 Philosophically, we can interpret this as the expected
return to undertaking risk (compared to no risk – a risk
“premium”).
 On the other hand, this is a model. It has virtues and
flaws. This is one of the flaws.

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing
 46/46

Summary
 Normal distribution approximation to binomial
 Approximate with a normal with same mean
and standard deviation
 Continuity correction
 Sums and central limit theorem
 Random walk model for stock prices
 Lognormal variables
 Alternative random walk model using logs

Marginal Plot of Listing vs IncomePC

Pie Chart of Percent vs Type Boxplot of Listing Scatterplot of Listing vs IncomePC Probability Plot of Listing Scatterplot of Listing vs IncomePC Histogram of Listing Empirical CDF of Listing
Normal - 95% CI Normal
Category
Meatball 900000 900000 900000 14

e  mc  
Peppero ni 99

2
Garlic 5.0% 100 Mean 369687
2.3% Mean 369687
Plain StDev 156865
Pepperoni 800000 StDev 156865 800000
Mushroom and Onion 21.8% Mushroom 800000 N 51 12 N 51
9.2% 95
Sausage
AD 0.994 80
Pepper and O nion 700000 90
P-Value 0.012
700000
Mushroom and Onion 700000 10
Garlic 80 1000000
600000 600000 60
Frequency

Pepper and O nion

Percent
Meatball 70
7.3% 600000
Listing

Listing

8
Percent

60 800000
500000 500000
Listing

50
40
Sausage 500000 40 6

Listing
5.8% 400000 30 400000 600000
400000 20 20
300000 300000 4
10 400000
300000 200000 5 200000 2 0
Mushroom Plain
16.2%
200000
32.5% 0 0 0 0 00 0 0 0 0 0
200000 100000 1 100000 0 00 00 00 00 00 00 00 00 00
15000 17500 20000 22500 25000 27500 30000 32500 0 200000 400000 600000 800000 1000000 15000 17500 20000 22500 25000 27500 30000 32500 200000 300000 400000 500000 600000 700000 800000 900000 1 00 20
0
30
0
40 500 60
0
70
0
8 00 90
0 15000 20000 25000 30000
IncomePC
100000 IncomePC Listing IncomePC Listing Listing