T-distribution

The student’s t-distribution is a bell-shaped probability distribution symmetrical about its mean. It is considered the best distribution to use for the construction of confidence intervals when:

  1. Dealing with small samples of less than 30 elements.
  2. The population variance is unknown.
  3. The distribution involved is either normal or approximately normal.

In the absence of outright normality of a given distribution, the t-distribution may still be appropriate for use if the sample size is large enough such that the central limit theorem can be applied, in which case the distribution is considered approximately normal.

The t-statistic, also called the t-score is given by:

t = (x – μ)/(S/√n)

Where:

x is the sample mean,

μ is the population mean,

S is the sample standard deviation,

n is the sample size

The t-distribution allows us to analyze those distributions that are not perfectly normal. It has the following properties:

  1. It has a mean of zero.
  2. Its variance = v/(v/2), where v represents the number of degrees of freedom and v ≥ 2.
  3. The variance is greater than 1 at all times, although it’s very close to one when there are many degrees of freedom. With a large number of degrees of freedom, the t-distribution resembles the normal distribution.
  4. Its tails are fatter than those of the normal distribution, indicating more probability in the tails.

T-distribution: The Degrees of Freedom

The t-distribution, just like several other distributions, has only one parameter: the degrees of freedom. The number of degrees of freedom refers to the number of independent observations (total number of observations less 1). i.e.

v = n-1

Hence, a sample of 10 observations/elements would be analyzed by the use of a t-distribution with 9 d.f. Similarly a 6 d.f. distribution would be used for a sample size of 7 observations.

Notations

It is standard practice for statisticians to use tα to represent the t-score that has a cumulative probability of (1 – α). Therefore, if we were to be interested in at-score having 0.9 cumulative probability, α would be equal to 1 – 0.9 = 0.1. We would denote the statistic as t0.1.

However, the value of tα depends on the number of degrees of freedom. For example,

t0.05, 2 = 2.92 where the second subscript (2) represents the number of d.f and,

t0.05, 20 = 1.725

Important Relationships

tα = -t1 – α  and t1 – α  = -tα

The above relationships are true because the t-distribution is symmetrical about the mean.

The t-distribution has thicker tails relative to the normal distribution.

t-distribution2

The shape of the t-distribution is dependent on the number of degrees of freedom so that as the number of d.f. increases, the distribution becomes more ‘spiked’ and its tails become thinner.

The table below represents one-tailed confidence intervals and various probabilities for a range of degrees of freedom.

t-distribution

 

Reading 11 LOS11i:

Describe properties of Student’s t-distribution and calculate and interpret its degrees of freedom.

Click here to access 3,000 CFA practice questions.

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