Denotation p(x) = P(X = x)

Probability density function 0 ≤ p(x) ≤ 1

(pdf) Characteristics
Interpretation of probability distribution
∑p(x) = 1

Denotation F(x) = P(X ≤ x)

Cumulative 
distribution function
(cdf) Characteristics 0 ≤ F(x) ≤ 1

Uniform distribution: probability distributions 

with equally likely outcomes

outcomes are discrete and have the same probability

Discrete uniform 
distribution
pdf: p(1) = p(2) = p(3) = ... = p(n)

Characteristics
cdf: F(x) = P(X ≤ x)
Discrete random variable

two outcomes “failure” and “success”

Bernoulli trial
the trials are independent, with the 
probability of success is constantly p

Binomial distribution
variable X where X is the number of successes in n Bernoulli trials

Definition of probability function: the probabilities 

Binomial random variable Formula:
of the possible outcomes of a random variable

Binomial tree

Uniform distribution

defined over a range that spans between 

Continuous uniform  Outcomes can only occur between a and b
a (lower limit) and b (upper limit)
distribution

pdf:

R4: Common probability distribution

Characteristics

cdf:

Type something

Skewness = 0

Characteristics
Kurtosis = 3 and excess kurtosis = 0

mean = mode = median

probabilities of outcomes further above and below the 

Random variable mean get smaller and smaller but do not go to zero

Univariate normal distribution probability of a single random variable

probability of a group of 

related random variable

Multivariate normal distribution

n means of the n 
Normal distribution series of returns
multivariate normal 
distribution for the returns 
on n assets n variances of the 
n series of returns

0.5n(n – 1) pair-​wise 
correlations

Continuous random variable

Confidence intervals

normal distribution that has been 

standardized so that it has a mean of 0 
and a standard deviation of 1
Standard normal distribution

Formula

Application: using z-​table 

Type something
to determine probability

Shortfall risk

Assumption
Application: Roy’s safety first criterion
Formula:

Interpretation: The higher SFR, the more optimal a portfolio is

function:

skewed to the right

Charatceristics:
Lognormal distribution useful for modeling asset prices 
bounded from below by zero
which never take negative values

Application: determine continuously compounded 

annual rate for 2 consecutive periods:

fatter tail than normal distribution

Student’s t-​distribution df = n – 1

the shape of t-​distribution approaches normal distribution when df increases

asymmetrical (positively skewed)

Chi-​square distribution
does not take on negative values

asymmetrical distributions bounded from below by 0

F distribution
the shape of F-​distribution approaches normal distribution when both the numerator (df1) 
and the denominator (df2) degrees of freedom increase

Monte Carlo simulation