chap 5-1 chapter 5 discrete random variables and probability distributions ef 507 quantitative...
TRANSCRIPT
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Chap 5-1
Chapter 5
Discrete Random Variables and Probability Distributions
EF 507
QUANTITATIVE METHODS FOR ECONOMICS AND FINANCE
FALL 2008
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Chap 5-2
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Chap 5-3
Introduction to Probability Distributions
Random Variable Represents a possible numerical value from
a random experiment
Random
Variables
Discrete Random Variable
ContinuousRandom Variable
Ch. 5 Ch. 6
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Chap 5-4
Discrete Random Variables
Can only take on a countable number of values
Examples:
Roll a die twiceLet X be the number of times 4 comes up (then X could be 0, 1, or 2 times)
Toss a coin 5 times. Let X be the number of heads
(then X = 0, 1, 2, 3, 4, or 5)
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Chap 5-5
Experiment: Toss 2 Coins. Let X = # heads.
T
T
Discrete Probability Distribution
4 possible outcomes
T
T
H
H
H H
Probability Distribution
0 1 2 x
x Value Probability
0 1/4 = 0.25
1 2/4 = 0.50
2 1/4 = 0.25
0.50
0.25
Pro
bab
ility
Show P(x) , i.e., P(X = x) , for all values of x:
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Chap 5-6
P(x) 0 for any value of x
The individual probabilities sum to 1;
(The notation indicates summation over all possible x values)
Probability DistributionRequired Properties
x
1P(x)
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Chap 5-7
Cumulative Probability Function
The cumulative probability function, denoted F(x0), shows the probability that X is less than or equal to x0
In other words,
)xP(X)F(x 00
0xx
0 P(x))F(x
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Chap 5-8
Expected Value
Expected Value (or mean) of a discrete distribution (Weighted Average)
Example: Toss 2 coins, x = # of heads, compute expected value of x:
E(x) = (0 x 0.25) + (1 x 0.50) + (2 x 0.25) = 1.0
x P(x)
0 0.25
1 0.50
2 0.25
x
P(x)x E(x) μ
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Chap 5-9
Variance and Standard Deviation
Variance of a discrete random variable X
Standard Deviation of a discrete random variable X
x
22 P(x)μ)(xσσ
x
222 P(x)μ)(xμ)E(Xσ
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Chap 5-10
Standard Deviation Example
Example: Toss 2 coins, X = # heads, compute standard deviation (recall E(x) = 1)
.707.50(.25)1)(2(.50)1)(1(.25)1)(0σ 222
Possible number of heads = 0, 1, or 2
x
2P(x)μ)(xσ
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Chap 5-11
Functions of Random Variables
If P(x) is the probability function of a discrete random variable X , and g(X) is some function of X , then the expected value of function g is
x
g(x)P(x)E[g(X)]
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Chap 5-12
Linear Functions of Random Variables
Let a and b be any constants.
a)
i.e., if a random variable always takes the value a,
it will have mean a and variance 0
b)
i.e., the expected value of b·X is b·E(x)
0Var(a)andaE(a)
2X
2X σbVar(bX)andbμE(bX)
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Chap 5-13
Linear Functions of Random Variables
Let random variable X have mean µx and variance σ2x
Let a and b be any constants. Let Y = a + bX Then the mean and variance of Y are
so that the standard deviation of Y is
XY bμabX)E(aμ
X22
Y2 σbbX)Var(aσ
XY σbσ
(continued)
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Chap 5-14
Probability Distributions
Continuous Probability
Distributions
Binomial
Hypergeometric
Poisson
Probability Distributions
Discrete Probability
Distributions
Uniform
Normal
Exponential
Ch. 5 Ch. 6
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Chap 5-15
The Binomial Distribution
Binomial
Hypergeometric
Poisson
Probability Distributions
Discrete Probability
Distributions
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Chap 5-16
Bernoulli Distribution
Consider only two outcomes: “success” or “failure” Let P denote the probability of success (1) Let 1 – P be the probability of failure (0) Define random variable X:
x = 1 if success, x = 0 if failure Then the Bernoulli probability function is
Prob(0)=P(0) (1 P) and P(1) P
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Chap 5-17
Bernoulli DistributionMean and Variance
The mean is µ = P
The variance is σ2 = P(1 – P)
P(1)PP)(0)(1P(x)xE(X)μX
P)P(1PP)(1P)(1P)(0
P(x)μ)(x]μ)E[(Xσ
22
X
222
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Chap 5-18
Sequences of x Successes in n Trials
The number of sequences with x successes in n independent trials is:
Where n! = n·(n – 1)·(n – 2)· . . . ·1 and 0! = 1
These sequences are mutually exclusive, since no two can occur at the same time
x)!(nx!
n!Cn
x
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Chap 5-19
Binomial Probability Distribution
1-A fixed number of observations, n e.g., 15 tosses of a coin; ten light bulbs taken from a warehouse
2-Two mutually exclusive and collectively exhaustive categories e.g., head or tail in each toss of a coin; defective or not defective light
bulb Generally called “success” and “failure” Probability of success is P , probability of failure is 1 – P
3-Constant probability for each observation e.g., Probability of getting a tail is the same each time we toss the
coin
4-Observations are independent The outcome of one observation does not affect the outcome of the
other
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Chap 5-20
Possible Binomial Distribution Settings
A manufacturing plant labels items as either defective or acceptable
A firm bidding for contracts will either get a contract or not
A marketing research firm receives survey responses of “Yes I will buy” or “No I will not”
New job applicants either accept the offer or reject it
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Chap 5-21
P(x) = probability of x successes in n trials, with probability of success P on each trial
x = number of ‘successes’ in sample, (x = 0, 1, 2, ..., n)
n = sample size (number of trials or observations)
P = probability of “success”
P(x)n
x ! n xP (1- P)X n X!
( ) !
Example: Flip a coin four times, let x = # heads:
n = 4
P = 0.5
1 - P = (1 - 0.5) = 0.5
x = 0, 1, 2, 3, 4
Binomial Distribution Formula
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Chap 5-22
Example: Calculating a Binomial Probability
What is the probability of one success in five observations if the probability of success is 0.1?
x = 1, n = 5, and P = 0.1
X n X
1 5 1
4
n!P(x 1) P (1 P)
x!(n x)!
5!(0.1) (1 0.1)
1!(5 1)!
(5)(0.1)(0.9)
0.32805
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Chap 5-23
n = 5 P = 0.1
n = 5 P = 0.5
Mean
0.2.4.6
0 1 2 3 4 5
x
P(x)
.2
.4
.6
0 1 2 3 4 5
x
P(x)
0
Binomial Distribution
The shape of the binomial distribution depends on the values of P and n
Here, n = 5 and P = 0.1
Here, n = 5 and P = 0.5
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Chap 5-24
Binomial DistributionMean and Variance
Mean
Variance and Standard Deviation
nPE(x)μ
P)nP(1-σ2
P)nP(1-σ
Where n = sample size
P = probability of success
(1 – P) = probability of failure
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Chap 5-25
n = 5 P = 0.1
n = 5 P = 0.5
Mean
0.2.4.6
0 1 2 3 4 5
x
P(x)
.2
.4
.6
0 1 2 3 4 5
x
P(x)
0
0.5(5)(0.1)nPμ
0.6708
0.1)(5)(0.1)(1P)nP(1-σ
2.5(5)(0.5)nPμ
1.118
0.5)(5)(0.5)(1P)nP(1-σ
Binomial Characteristics
Examples
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Chap 5-26
Using Binomial Tables (Table 2, p.844)
N x … p=.20 p=.25 p=.30 p=.35 p=.40 p=.45 p=.50
10 0
1
2
3
4
5
6
7
8
9
10
…
…
…
…
…
…
…
…
…
…
…
0.1074
0.2684
0.3020
0.2013
0.0881
0.0264
0.0055
0.0008
0.0001
0.0000
0.0000
0.0563
0.1877
0.2816
0.2503
0.1460
0.0584
0.0162
0.0031
0.0004
0.0000
0.0000
0.0282
0.1211
0.2335
0.2668
0.2001
0.1029
0.0368
0.0090
0.0014
0.0001
0.0000
0.0135
0.0725
0.1757
0.2522
0.2377
0.1536
0.0689
0.0212
0.0043
0.0005
0.0000
0.0060
0.0403
0.1209
0.2150
0.2508
0.2007
0.1115
0.0425
0.0106
0.0016
0.0001
0.0025
0.0207
0.0763
0.1665
0.2384
0.2340
0.1596
0.0746
0.0229
0.0042
0.0003
0.0010
0.0098
0.0439
0.1172
0.2051
0.2461
0.2051
0.1172
0.0439
0.0098
0.0010
Examples: n = 10, x = 3, P = 0.35: P(x = 3|n =10, p = 0.35) = 0.2522
n = 10, x = 8, P = 0.45: P(x = 8|n =10, p = 0.45) = 0.0229
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Chap 5-27
Using PHStat
Select PHStat / Probability & Prob. Distributions / Binomial…
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Chap 5-28
Using PHStat
Enter desired values in dialog box
Here: n = 10
p = .35
Output for x = 0
to x = 10 will be
generated by PHStat
Optional check boxes
for additional output
(continued)
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Chap 5-29
P(x = 3 | n = 10, P = .35) = .2522
PHStat Output
P(x > 5 | n = 10, P = .35) = .0949
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Chap 5-30
The Hypergeometric Distribution
Binomial
Poisson
Probability Distributions
Discrete Probability
Distributions
Hypergeometric
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Chap 5-31
The Hypergeometric Distribution
“n” trials in a sample taken from a finite population of size N
Sample taken without replacement
Outcomes of trials are dependent
Concerned with finding the probability of “X” successes in the sample where there are “S” successes in the population
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Chap 5-32
Hypergeometric Distribution Formula
WhereN = population sizeS = number of successes in the population
N – S = number of failures in the populationn = sample sizex = number of successes in the sample
n – x = number of failures in the sample
n)!(Nn!N!
x)!nS(Nx)!(nS)!(N
x)!(Sx!S!
C
CCP(x)
Nn
SNxn
Sx
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Chap 5-33
Using the Hypergeometric Distribution
■ Example: 3 different computers are checked from 10 in the department. 4 of the 10 computers have illegal software loaded. What is the probability that 2 of the 3 selected computers have illegal software loaded?
N = 10 n = 3 S = 4 x = 2
The probability that 2 of the 3 selected computers have illegal software loaded is 0.30, or 30%.
0.3120
(6)(6)
C
CC
C
CC2)P(x
103
61
42
Nn
SNxn
Sx
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Chap 5-34
Hypergeometric Distribution in PHStat
Select:PHStat / Probability & Prob. Distributions / Hypergeometric …
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Chap 5-35
Hypergeometric Distribution in PHStat
Complete dialog box entries and get output …
N = 10 n = 3S = 4 x = 2
P(X = 2) = 0.3
(continued)
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Chap 5-36
The Poisson Distribution
Binomial
Hypergeometric
Poisson
Probability Distributions
Discrete Probability
Distributions
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Chap 5-37
The Poisson Distribution
Apply the Poisson Distribution when:
1-You wish to count the number of times an event occurs in a given continuous interval
2-The probability that an event occurs in one subinterval is very small and is the same for all subintervals
3-The number of events that occur in one subinterval is independent of the number of events that occur in the other subintervals
4-There can be no more than one occurrence in each subinterval
5-The average number of events per unit is (lambda)
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Chap 5-38
Poisson Distribution Formula
where:
x = number of successes per unit
= expected number of successes per unit
e = base of the natural logarithm system (2.71828...)
x!
λeP(x)
xλ
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Chap 5-39
Poisson Distribution Characteristics
Mean
Variance and Standard Deviation
λE(x)μ
λ]σ2 2)[( XE
λσ
where = expected number of successes per unit
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Chap 5-40
Using Poisson Tables (Table 5, p.853)
X
0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90
0
1
2
3
4
5
6
7
0.9048
0.0905
0.0045
0.0002
0.0000
0.0000
0.0000
0.0000
0.8187
0.1637
0.0164
0.0011
0.0001
0.0000
0.0000
0.0000
0.7408
0.2222
0.0333
0.0033
0.0003
0.0000
0.0000
0.0000
0.6703
0.2681
0.0536
0.0072
0.0007
0.0001
0.0000
0.0000
0.6065
0.3033
0.0758
0.0126
0.0016
0.0002
0.0000
0.0000
0.5488
0.3293
0.0988
0.0198
0.0030
0.0004
0.0000
0.0000
0.4966
0.3476
0.1217
0.0284
0.0050
0.0007
0.0001
0.0000
0.4493
0.3595
0.1438
0.0383
0.0077
0.0012
0.0002
0.0000
0.4066
0.3659
0.1647
0.0494
0.0111
0.0020
0.0003
0.0000
Example: Find P(X = 2) if = 0.50
0.50 2e (0.50)( 2) 0.0758
! 2!
XeP X
X
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Chap 5-41
Example 1: The average number of trucks arriving on any one day at a truck depot in a certain city is known to be 12. What is the probability that on a given day fewer than nine trucks will arrive at this depot?
X: number of trucks arriving on a given day. Lambda=12
P(X<9) = SUM[p(x;12)] from 0 to 8 = 0.1550
Example 2: The number of complaints that a call center receives per day is a random variable having a Poisson distribution with lambda=3.3. Find the probability that the call center will receive only two complaints on any given day.
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Chap 5-42
Graph of Poisson Probabilities
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0 1 2 3 4 5 6 7
x
P(x
)X
=
0.50
0
1
2
3
4
5
6
7
0.6065
0.3033
0.0758
0.0126
0.0016
0.0002
0.0000
0.0000P(X = 2) = 0.0758
Graphically:
= 0.50
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Chap 5-43
Poisson Distribution Shape
The shape of the Poisson Distribution depends on the parameter :
0.00
0.05
0.10
0.15
0.20
0.25
1 2 3 4 5 6 7 8 9 10 11 12
x
P(x
)
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0 1 2 3 4 5 6 7
x
P(x
)
= 0.50 = 3.00
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Chap 5-44
Poisson Distribution in PHStat
Select:PHStat / Probability & Prob. Distributions / Poisson…
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Chap 5-45
Poisson Distribution in PHStat
Complete dialog box entries and get output …
P(X = 2) = 0.0758
(continued)
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Chap 5-46
Joint Probability Functions
A joint probability function is used to express the probability that X takes the specific value x and simultaneously Y takes the value y, as a function of x and y
The marginal probabilities are
y)YxP(Xy)P(x,
y
y)P(x,P(x) x
y)P(x,P(y)
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Chap 5-47
Conditional Probability Functions
The conditional probability function of the random variable Y expresses the probability that Y takes the value y when the value x is specified for X.
Similarly, the conditional probability function of X, given Y = y is:
P(x)
y)P(x,x)|P(y
P(y)
y)P(x,y)|P(x
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Chap 5-48
Independence
The jointly distributed random variables X and Y are said to be independent if and only if their joint probability function is the product of their marginal probability functions:
for all possible pairs of values x and y
A set of k random variables are independent if and only if
P(x)P(y)y)P(x,
)P(x))P(xP(x)x,,x,P(x k21k21
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Chap 5-49
Covariance
Let X and Y be discrete random variables with means μX and μY
The expected value of (X - μX)(Y - μY) is called the covariance between X and Y
For discrete random variables
An equivalent expression is
x y
yxYX y))P(x,μ)(yμ(x)]μ)(YμE[(XY)Cov(X,
x y
yxyx μμy)xyP(x,μμE(XY)Y)Cov(X,
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Chap 5-50
Covariance and Independence The covariance measures the strength of the linear relationship
between two variables
If two random variables are statistically independent, the covariance between them is 0
The converse is not necessarily true
Example: mean_x=0; mean_y= -1/3; E(xy)=0; sigma_xy=0
So the covariance is 0, but for x=-1 and y=-1 f(x,y) is not equal to g(x)h(y) x
-1 0 1-1 1/6 1/3 1/6
y 0 0 0 01 1/6 0 1/6
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Chap 5-51
Correlation
The correlation between X and Y is:
ρ = 0 no linear relationship between X and Y ρ > 0 positive linear relationship between X and Y
when X is high (low) then Y is likely to be high (low) ρ = +1 perfect positive linear dependency
ρ < 0 negative linear relationship between X and Y when X is high (low) then Y is likely to be low (high) ρ = -1 perfect negative linear dependency
YXσσ
Y)Cov(X,Y)Corr(X,ρ
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Chap 5-52
Portfolio Analysis
Let random variable X be the price for stock A
Let random variable Y be the price for stock B
The market value, W, for the portfolio is given by the
linear function
(a is the number of shares of stock A,
b is the number of shares of stock B)
bYaXW
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Chap 5-53
Portfolio Analysis
The mean value for W is
The variance for W is
or using the correlation formula
(continued)
YX
W
bμaμ
bY]E[aXE[W]μ
Y)2abCov(X,σbσaσ 2Y
22X
22W
YX2Y
22X
22W σY)σ2abCorr(X,σbσaσ
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Chap 5-54
Portfolio Example
Investment X: μx = 50 σx = 43.30
Investment Y: μy = 95 σy = 193.21
σxy = 8250
Suppose 40% of the portfolio (P) is in Investment X and 60% is in Investment Y:
The portfolio return and portfolio variability are between the values for investments X and Y considered individually
E(P) (0.4) (50) (0.6) (95) 77
2 2 2 2σ (0.4) (43.30) (0.6) (193.21) 2(0.4)(0.6)(8250)
133.04P
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Chap 5-55
Interpreting the Results for Investment Returns
The aggressive fund has a higher expected return, but much more risk
μy = 95 > μx = 50 but
σy = 193.21 > σx = 43.30
The Covariance of 8,250 indicates that the two investments are positively related and will vary in the same direction
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Chap 5-56
Example: Investment Returns
Return per $1,000 for two types of investments
P(xiyi) Economic condition Passive Fund X Aggressive Fund Y
0.2 Recession - $ 25 - $200
0.5 Stable Economy + 50 + 60
0.3 Expanding Economy + 100 + 350
Investment
E(x) = μx = (-25)(0.2) +(50)(0.5) + (100)(0.3) = 50
E(y) = μy = (-200)(0.2) +(60)(0.5) + (350)(0.3) = 95
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Chap 5-57
Covariance for Investment Returns
P(xiyi) Economic condition Passive Fund X Aggressive Fund Y
0.2 Recession - $ 25 - $200
0.5 Stable Economy + 50 + 60
0.3 Expanding Economy + 100 + 350
Investment
Cov(X,Y) (-25 50)(-200 95)(0.2) (50 50)(60 95)(0.5)
(100 50)(350 95)(0.3)
8,250
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Chap 5-58
Computing the Standard Deviation for Investment Returns
P(xiyi) Economic condition Passive Fund X Aggressive Fund Y
0.2 Recession - $ 25 - $200
0.5 Stable Economy + 50 + 60
0.3 Expanding Economy + 100 + 350
Investment
43.30
(0.3)50)(100(0.5)50)(50(0.2)50)(-25σ 222X
193.71
(0.3)95)(350(0.5)95)(60(0.2)95)(-200σ 222y