Continous Compounding
- Thread starter harishaha
- Start date
Sure,
Linda Allen calls it "time consistency" which may be a nice way of saying, it is really convenient for modeling.
as in:
year 1 return is 3%, year 2 return is 4%.
under continuous, to get the two-year is to simply add them which is utterly convenient:
EXP(3%)*EXP(4%) = EXP(7%)
More importantly, if (r) is a random variable, the sum of two normal randoms will also be normal, and this is desirable. Convenience: to be able to generate multi-period random variables by adding (continuously compounded) random vars is easier.
But let me add, part of the point of the Tuckman/Hull section, for the the FRM candidate, is to be able to convert back and forth; i.e., given continuous, convert to semiannual. Given monthly, convert to continuous. Do this enough and you'll see the point is: it's merely "units." It is (i) important to clarify the compound frequency being used, but (ii) a given interest rate can be expressed in several different equivalent frequencies. To your point, I may illustrate with CC but you can rightly convert that to a "realistic" daily/weekly/monthly basis and both are correct if they are labeled correctly.
David
Linda Allen calls it "time consistency" which may be a nice way of saying, it is really convenient for modeling.
as in:
year 1 return is 3%, year 2 return is 4%.
under continuous, to get the two-year is to simply add them which is utterly convenient:
EXP(3%)*EXP(4%) = EXP(7%)
More importantly, if (r) is a random variable, the sum of two normal randoms will also be normal, and this is desirable. Convenience: to be able to generate multi-period random variables by adding (continuously compounded) random vars is easier.
But let me add, part of the point of the Tuckman/Hull section, for the the FRM candidate, is to be able to convert back and forth; i.e., given continuous, convert to semiannual. Given monthly, convert to continuous. Do this enough and you'll see the point is: it's merely "units." It is (i) important to clarify the compound frequency being used, but (ii) a given interest rate can be expressed in several different equivalent frequencies. To your point, I may illustrate with CC but you can rightly convert that to a "realistic" daily/weekly/monthly basis and both are correct if they are labeled correctly.
David
Similar threads
