Visual Quantitative Finance: A New Look at Option Pricing, Risk Management, and Structured Securities

6. The Lognormal Distribution and Calc Engine

The lognormal distribution is the most commonly used random variable in finance to describe stock and other asset prices. Unlike the normal distribution, it is bounded by zero on the downside, which highlights the fact that stock prices cannot go negative. Whenever you look at a graph of stock price probabilities, it is more than likely a lognormal distribution. The distribution is also frequently used in the derivation of the Black-Scholes formula and Value-at-Risk (VaR).

But if it is so important, why hasn’t it been used here? In a way, it has. It is implied in the option pricing spreadsheet. And if you change the way stock prices are spaced, you can see it. The lognormal distribution is more of ...