Question

what. is a normal distribution? why is the concept of standard deviation relevant to risk. exposure?

Answer 1

the normal distribution is a very common continuous probability distribution. Normal distributions are important in statistics and are often used in the natural and social sciences to represent real-valued random variables whose distributions are not known.A random variable with a Gaussian distribution is said to be normally distributed and is called a normal deviate.

In investing, standard deviation is used as an indicator of market volatility and therefore of risk. The more unpredictable the price action and the wider the range, the greater the risk. Range-bound securities, or those that do not stray far from their means, are not considered a great risk because it can be assumed with relative certainty that they continue to behave in the same way. The riskier the security, the greater potential for payout as well as loss.

When using standard deviation to measure risk in the stock market, the underlying assumption is that the majority of price activity follows the pattern of a normal distribution. In a normal distribution, individual values fall within one standard deviation of the mean, above or below, 68 percent of the time. Values are within two standard deviations 95 percent of the time.