Earn your certification as a Financial Modeling & Valuation Analyst (FMVA)®. Register today!

Confidence Interval

An estimate of an interval in statistics that may contain a population parameter

What is Confidence Interval?

A confidence interval is an estimate of an interval in statistics that may contain a population parameter. The unknown population parameter is found through a sample parameter calculated from the sampled data. For example, the population mean μ is found using the sample mean x̅.

The interval is generally defined by its lower and upper bounds. The confidence interval is expressed as a percentage (the most frequently quoted percentages are 90%, 95%, and 99%). The percentage is called the confidence level.

 

Confidence Interval

 

The concept of the confidence interval is very important in statistics (hypothesis testing) since it is used as a measure of uncertainty. The concept was introduced by Polish mathematician and statistician Jerzy Neyman in 1937.

 

CFI’s Math for Corporate Finance Course explores the financial mathematics concepts required for Financial Modeling.

 

Interpretation of Confidence Interval

The proper interpretation of confidence interval is probably the most challenging aspect of this statistical concept. One example of the most common interpretation of the concept is the following:

There is a 95% probability that in the future, the true value of the population parameter (e.g., mean) would fall within X [lower bound] and Y [upper bound] interval.

 

In addition, we may interpret the confidence interval using the statement below:

We are 95% confident that the interval between X [lower bound] and Y [upper bound] contains the true value of the population parameter.

 

However, it would be inappropriate to state the following:

There is a 95% probability that the interval between X [lower bound] and Y [upper bound] contains the true value of the population parameter.

 

The statement above is the most common misconception about confidence interval. After the statistical interval is calculated, the interval can only either contain the population parameter or not. Nevertheless, the intervals may vary among the samples, while the true population parameter is the same regardless of the sample.

Therefore, the probability statement regarding the confidence interval can be made in the case when the confidence intervals are recalculated for the number of samples.

 

How to Calculate the Confidence Interval?

The interval is calculated using the following steps:

  1. Gather the sample data.
  2. Calculate the sample mean .
  3. Determine whether a population standard deviation is known or unknown.
  4. If a population standard deviation is known, we can use a z-score for the corresponding confidence level.
  5. If a population standard deviation is unknown, we can use a t-statistic for the corresponding confidence level.
  6. Find the lower and upper bounds of the confidence interval using the following formulas:

    a. Known population standard deviation

Known Population Standard Deviation - Formula

    b. Unknown population standard deviation

Unknown Population Standard Deviation - Formula

 

More Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Financial Math Glossary
  • Algorithms
  • Geometric Mean
  • Quantitative Finance

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.