Z- Score
What is Z- score?
A z-score describes the position of a raw score in terms of its distance from the
mean, when measured in standard deviation units.
In finance, Z-scores are measures of an observation's variability and can be used by
traders to help determine market volatility. The Z-score is also sometimes known as
the Altman Z-score.
In general, a Z-score below 1.8 suggests a company might be headed for
bankruptcy, while a score closer to 3 suggests a company is in solid financial
positioning.
How do you calculate the z-score?
The basic z score formula for a sample is:
z = (x – μ) / σ
When you have multiple samples and want to describe the standard deviation of
those sample means, you would use this z score formula:
z = (x – μ) / (σ / √n)
The Z Score Formula: for One Sample
For example, let’s say you have a test score of 190. The test has a mean (μ) of 150
and a standard deviation (σ) of 25. Assuming a normal distribution, your z score
would be:
z = (x – μ) / σ
= (190 – 150) / 25 = 1.6
The z score tells you how many standard deviations from the mean your score is. In this
example, your score is 1.6 standard deviations above the mean.
Comparison of scores measured on different scales
When scores are measured on different scales, they may be converted to z-scores to
aid comparison. Give the following example comparing student scores on the SAT
and ACT high school tests. The table shows the mean and standard deviation for
total score on the SAT and ACT. Suppose that student A scored 2000 on the SAT,
and student B scored 25 on the ACT. Which student performed better relative to
other test-takers?
Comparison of scores measured on different scales
The z-score for student A
z = (x – μ) / σ
= (2000 – 1500) / 300 = 1.67
The z-score for student B
z = (x – μ) / σ
= (25 – 21) / 5 = 0.80
Because student A has a higher z-score than student B, student A performed better compared
to other test-takers than did student B.
Z Score Formula: Standard Error of the Mean
Example problem: In general, the mean height of women is 65″ with a standard deviation of
3.5″. What is the probability of finding a random sample of 50 women with a mean height of
70″, assuming the heights are normally distributed?
z = (x – μ) / (σ / √n)
= (70 – 65) / (3.5/√50) = 5 / 0.495 = 10.1
The key here is that we’re dealing with a sampling distribution of means, so we know we
must include the standard error in the formula. We also know that 99% of values fall within
3 standard deviations from the mean in a normal probability distribution. Therefore, there’s
less than 1% probability that any sample of women will have a mean height of 70″.
Z scores and Standard Deviations
The value of the z-score tells you how many standard deviations you are away from
the mean. If a z-score is equal to 0, it is on the mean.
A positive z-score indicates the raw score is higher than the mean average. For
example, if a z-score is equal to +1, it is 1 standard deviation above the mean.
A negative z-score reveals the raw score is below the mean average. For example, if
a z-score is equal to -2, it is 2 standard deviations below the mean.
Z scores and Standard Deviations
The SND (i.e., z-distribution) is always the same shape as the raw score distribution. For example, if the
distribution of raw scores if normally distributed, so is the distribution of z-scores.
The mean of any SND always = 0.
The standard deviation of any SND always = 1. Therefore, one standard deviation of the raw score (whatever
raw value this is) converts into 1 z-score unit.
Z scores and Standard Deviations
The SND allows researchers to calculate the probability of randomly obtaining a score from the distribution (i.e.,
sample). For example, there is a 68% probability of randomly selecting a score between -1 and +1 standard deviations
from the mean
The probability of randomly selecting a score between -1.96 and +1.96 standard deviations from the mean is 95% (see
Fig. 4). If there is less than a 5% chance of a raw score being selected randomly, then this is a statistically significant
result.
Positive Z Score Table
Negative Z Score Table
