Distribution of Equity Returns
categories: Factor and Risk Modeling, PMA, Equities, Research Paper, KAHN Ronald N., general
The distribution of equity returns plays a fundamental role in investment management. It captures the equity risk/return tradeoff, influences trading and limit orders, and directly affects equity option pricing. It is almost universally assumed that equity returns are normally distributed. This assumption is a convenient one, since the normal distribution is both familiar and mathematically tractable. But is the assumption accurate? This article will investigate the assumption, particularly when applied to the analysis of residual or active equity returns. This article will also briefly look at the distribution of daily returns as opposed to monthly returns.