Lesson 4 of 14 · All lessons in this module
- Random variables: PMF, PDF and CDF
- Expected value, variance and standard deviationVideo lesson
- Variance and covariance shortcuts, and the law of large numbers
- Discrete distributions: uniform, binomial and Poisson
- Continuous uniform and normal distributions, and simulating random draws
- Log-normal and logistic distributions, and the moments of key distributions
- Integrated cases: reading probabilities and moments from a return model
- Conditional probability and probability trees
- Conditional expected values and variancesVideo lesson
- Covariance from a joint probability function
- Joint, marginal and conditional distributions as information arrives
- Bayes' formula: updating a probability with new informationVideo lesson
- Bayes in practice: diffuse priors, missing inputs and screening tests
- Integrated cases: a tree with model forecasts and a Bayes update
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 4 of 14 · 15 min
Discrete distributions: uniform, binomial and Poisson
Three discrete distributions do most of the work in finance: the uniform for equally likely outcomes, the binomial for counting successes in a fixed number of yes/no trials, and the Poisson for counting rare events in a period.
In short
- Discrete uniform: n equally likely outcomes, each with probability 1/n. For consecutive integers from a to b, mean and variance .
- Bernoulli: one trial, success with probability p. Binomial: the number of successes in n independent Bernoulli trials, with mean np and variance np(1 − p).
- The binomial model of stock prices moves the price up by a factor u or down by d each step, so after i ups and j downs .
- With large n and both np and n(1 − p) above 5, a binomial is well approximated by the normal .
- Poisson: the number of events in an interval when events arrive independently at a constant rate λ. Mean = variance = λ; skewness .
- In default-intensity models , , and the expected time to default is .
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