E370

2/9/2015
Expected Values:
Discrete Random Variables
Sums of Random Variables
Discrete variables
can assume only a countable number of different
values
gaps between values along the number line
It is possible to list all X values and the associated
P(X) in Probability Distributions
Random variables
Actual outcomes are determined by chance.
Notation:
X outcome
P(X) probability of an outcome

Discrete Random Variables

 This is a frequency
distribution: Number of
drinks consumed per occasion
by E370 students who
classified themselves as Light
Drinkers
This is also a probability
distribution for a random
variable: Number of drinks
consumed per occasion by
E370 students who classified
themselves as Light Drinkers

X fi / fi = fi/n X P(X)
0 0.56 0 0.56
1 0.13 1 0.13
2 0.07 2 0.07
3 0.07 3 0.07
4 0.04 4 0.04
5 0.13 5 0.13
 Whatis the expected number of drinks
consumed per occasion by light-drinking E370
students? = ( )
X P(X) Products Sum
0 0.56 =0*0.56 = 0 0
1 0.13 =1*0.13 = 0.13 +0.13
2 0.07 =2*0.07 = 0.14 +0.14
3 0.07 =3*0.07 = 0.21 +0.21
4 0.04 =4*0.04 = 0.16 +0.16
5 0.13 =5*0.13 = 0.65 +0.65 = 1.29

Expected Values
 Whatis the expected number of drinks
consumed per occasion by light-drinking E370
students? = ( )
X P(X) Products Sum
0 0.56 =0*0.56 = 0 0
1 0.13 =1*0.13 = 0.13 +0.13
2 0.07 =2*0.07 = 0.14 +0.14
3 0.07 =3*0.07 = 0.21 +0.21
4 0.04 =4*0.04 = 0.16 +0.16
5 0.13 =5*0.13 = 0.65 +0.65 = 1.29

Expected Values
 Whatis the expected number of drinks
consumed per occasion by light-drinking E370
students? = ( )
X P(X) Products Sum
0 0.56 =0*0.56 = 0 0
1 0.13 =1*0.13 = 0.13 +0.13
2 0.07 =2*0.07 = 0.14 +0.14
3 0.07 =3*0.07 = 0.21 +0.21
4 0.04 =4*0.04 = 0.16 +0.16
5 0.13 =5*0.13 = 0.65 +0.65 = 1.29

Expected Values
 What is the expected variance of the number of
drinks consumed per occasion by light-drinking
E370 students? = () ( )
X P(X) (X-E(X)) (X-E(X))2 (X-E(X))2*P(X)
0 0.56 (0-1.29) (0-1.29)2 (0-1.29)2*0.56 0.931896
1 0.13 (1-1.29) (1-1.29)2 (1-1.29)2*0.13 + 0.010933
2 0.07 (2-1.29) (2-1.29)2 (2-1.29)2*0.07 + 0.035287
3 0.07 (3-1.29) (3-1.29)2 (3-1.29)2*0.07 + 0.204687
4 0.04 (4-1.29) (4-1.29)2 (4-1.29)2*0.04 + 0.293764
+ 1.789333
5 0.13 (5-1.29) (5-1.29)2 (5-1.29)2*0.13
= 3.27

More Expected Values

 What is the expected variance of the number of
drinks consumed per occasion by light-drinking
E370 students? = () ( )
X P(X) (X-E(X)) (X-E(X))2 (X-E(X))2*P(X)
0 0.56 (0-1.29) (0-1.29)2 (0-1.29)2*0.56 0.931896
1 0.13 (1-1.29) (1-1.29)2 (1-1.29)2*0.13 + 0.010933
2 0.07 (2-1.29) (2-1.29)2 (2-1.29)2*0.07 + 0.035287
3 0.07 (3-1.29) (3-1.29)2 (3-1.29)2*0.07 + 0.204687
4 0.04 (4-1.29) (4-1.29)2 (4-1.29)2*0.04 + 0.293764
+ 1.789333
5 0.13 (5-1.29) (5-1.29)2 (5-1.29)2*0.13
= 3.27

More Expected Values

 What is the expected variance of the number of
drinks consumed per occasion by light-drinking
E370 students? = () ( )
X P(X) (X-E(X)) (X-E(X))2 (X-E(X))2*P(X)
0 0.56 (0-1.29) (0-1.29)2 (0-1.29)2*0.56 0.931896
1 0.13 (1-1.29) (1-1.29)2 (1-1.29)2*0.13 + 0.010933
2 0.07 (2-1.29) (2-1.29)2 (2-1.29)2*0.07 + 0.035287
3 0.07 (3-1.29) (3-1.29)2 (3-1.29)2*0.07 + 0.204687
4 0.04 (4-1.29) (4-1.29)2 (4-1.29)2*0.04 + 0.293764
+ 1.789333
5 0.13 (5-1.29) (5-1.29)2 (5-1.29)2*0.13
= 3.27

More Expected Values

 What is the expected variance of the number of
drinks consumed per occasion by light-drinking
E370 students? = () ( )
X P(X) (X-E(X)) (X-E(X))2 (X-E(X))2*P(X)
0 0.56 (0-1.29) (0-1.29)2 (0-1.29)2*0.56 0.931896
1 0.13 (1-1.29) (1-1.29)2 (1-1.29)2*0.13 + 0.010933
2 0.07 (2-1.29) (2-1.29)2 (2-1.29)2*0.07 + 0.035287
3 0.07 (3-1.29) (3-1.29)2 (3-1.29)2*0.07 + 0.204687
4 0.04 (4-1.29) (4-1.29)2 (4-1.29)2*0.04 + 0.293764
+ 1.789333
5 0.13 (5-1.29) (5-1.29)2 (5-1.29)2*0.13
= 3.27

More Expected Values

 Expected Variance = 3.27drinks2
Standard Deviation = SQRT(3.27) = 1.81 drinks
Is that a lot of variability or a little?
Tointerpret a statistic, we need context.
The range of the variable is 5.
The expected value is 1.29.
Two standard deviations above the mean takes us
almost to 5.
We cant go two standard deviations below the mean
because we run into 0 and we cant have negative
drinks.

Some meaning please!

 = ( )

= () ( )

Summary of Expected Value

Formulas For Discrete Data
 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)
V(X) =
= 681275
681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)
V(X) =
= 681275
681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)
V(X) =
= 681275
681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)
V(X) =
= 681275
681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)
V(X) =
= 681275
681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)V(X)
= 681275.11
= 681275 $825.40

Practice expected values

 An automobile insurance company estimates the following
loss probabilities for the next year on a $10,000 motorcycle.
What is the expected loss, the expected standard deviation
of loss, and the value of the median loss?

Loss
% Loss P(Loss) (Xi)*P(Xi) (XiiE(X))22 *P(Xii)
Value
(10000-285)
(10000-285)22*0.001
*0.001
Total loss 10000 0.001 10 =94381.23
=94381.23
50% loss 5000 0.010 50 222312.3
222312.3
25% loss 2500 0.050 125 245311.3
245311.3
10% loss 1000 0.100 100 51122.5
51122.5
0% loss 0 0.839 0 68147.78
68147.78 SQRT
E(X) $285 V(X)V(X)
= 681275.11
= 681275 $825.40

Practice expected values

What does the loss function look like?

Continuing the problem

1. Recognize a valid probability (frequency) distribution.
2. Recognize that the answer is a dollar value, and
translate % loss to dollars.
3. Sketch a frequency polygon (or histogram) correctly.
4. Calculate expected value.
5. Calculate expected standard deviation.
6. Definition of a median.
7. Correctly interpret graph.
8. Correctly interpret statistics.

What concepts were

necessary for this problem?
Univariate Random Variables
Those we measure or count from raw data

Multivariate Random Variables

We COULD measure and/or count these, but we can
also get them by adding Univariate Random
Variables, also called combinations.

Where do random variables

come from?
 LINEAR
What does that mean? A variable can
have a constant added to or subtracted from it,
be multiplied or divided by a constant,
be added to or subtracted from another variable,
or any combination of the above.
If the formula for the new variable contains functions such
as square roots or logarithms, then the combination is not
linear.
Forexample, if Y = 3X1 + 2X2 then Y is a linear
combination of the variables X1 and X2.

What is the most common

combination method?
Ifwe add random variables then the
new variable is also random.
o That means it must have a distribution.
o That means it must have expected
values.

New Random Variables

 Original data Original data
Statistic plus c times c
Changes . . . Changes . . .
Mean +c c*
Median MED + c c*MED
Mode Mode + c c*Mode
Range No Change c*Range
Variance No Change c2*2

St. Deviation No Change |c|*

Summary
 The president of Midwest Foods is thinking of
building a meat distribution facility on the
outskirts of Chicago. Contribution per pound to
profits is known to be $0.40 for pork and $0.50
for beef. The president is interested in overall
profits. Define a relevant random variable.

TP = 0.4*P + 0.5*B

A practical problem
 Itis known that expected pork sales per
month are 2300 pounds. Expected beef sales
per month are 4200. Calculate the expected
value of profits.
E(TP) = E(0.4P + 0.5B)
= E(0.4P) + E(0.5B)
= 0.4*E(P) + 0.5*E(B)
= 0.4*2300 + 0.5*4200
= 920 + 2100 = $3,020

Expected Value
The expected value of the sum of random
variables is the sum of the expected values
of its parts.
For S= aX + bY + c
E(S) =E(aX + bY + c)
=E(aX) + E(bY) + (E(c))
=a*E(X) + b*E(Y) + c

(E(c) = c)

Big News
 Theexpected standard deviation of pork
sales is1187 pounds; the expected standard
deviation of beef sales is 1400 pounds.
Calculate the expected standard deviation of
profits, assuming pork and beef sales are
independent of one another.
o Calculate Variance
o Take Square Root of it.

Independent
Expected Standard Deviation
 V(TP) = V(0.4*P + 0.5*B)

=V(0.4*P) + V(0.5*B)

=(0.4)2 *V(P) + (0.5)2 *V(B)

=(0.16) *(1408969) + (0.25) * (1960000)

=225435.04 + 490000 = 715435.04

Thus,the standard deviation is =SQRT(715435.04) =

$845.83

Variance Calculations
The expected variance of the sum of
random variables is the sum of the
expected variances of its parts . . .
For S= aX + bY + c
V(S) = V(aX + bY + c)
=V(aX) + V(bY) + V(c)
=a2*V(X) + b2*V(Y) + 0
V(c) = 0
(. . . plus the expected covariances of its variable pairs.)

More Big News

 The covariance between pork and beef sales is
1,160,000. Calculate the expected standard
deviation of profits that includes this information.
Must include the variation from between the
variables: 2*a*b*pb = 2*(0.4)*(0.5)*(1160000)
= 64,000
715435.04 + (64,000) = 651435.04
Thus, the standard deviation is =SQRT(651435.04)
= $807.12

Dependent
Expected Standard Deviation
Expected Values of
Sums of 2 Random Variables

E(aX+bY)=aE(X) + bE(Y) = ax + by

V(aX+bY)=a2V(X) + b2V(Y) + 2abCOV(X,Y)

= a22x + b22y +2abxy

Expected Values Summary

Expected Values of
Sums of 3 Random Variables

E(aX+bY+cZ)=aE(X) + bE(Y) + cE(Z)

= ax + by + cz

V(aX+bY+cZ)=a2V(X)+b2V(Y)+c2V(Z)
+2abCOV(X,Y)+2bcCOV(Y,Z)+2caCOV(Z,X)
= a22x+b22y+c22z +2abxy+2bcyz+2cazx

Expected Values Summary

 IBM stock has an expected value of $91.40 and a
standard deviation of $2.22. Microsoft stock has an
expected value of $29.20 and a standard deviation of
$0.83. A portfolio consists of 2 shares of each stock.
Write the formula for the total value of the portfolio.
What is the expected value of the portfolio?
What is the expected variance in value of the
portfolio, assuming the stocks are unrelated?
The stocks have a correlation coefficient of 0.95.
Given this additional information, how would your
calculation of the variance of the portfolio change?

A portfolio example
 TVP=2I + 2M

E(TVP) =E(2I + 2M) = 2*E(I) + 2*E(M) =

2*(91.40)+2*(29.20) = 182.80 + 58.40 = $241.20

V(TVP) =V(2I + 2M) = 22*V(I) + 22*V(M) = 4*V(I) +

4*V(M) = 4*4.9284 + 4*0.6889 = 19.7136 + 2.7556
= 22.4692

sTVP = SQRT(22.4692) = 4.74

Statistics

= . = =
..
= . . . = .

Covariance Term: . =
.

Total Variance: 22.4692 + 14.00 = 36.4692

stvp= SQRT(36.4392) = 6.04

How do we use the correlation?

 Mr.Tippler of the Teetotal party presented us
with a linear combination of random variables
with respect to trade between the US and
Barbados: Xn = X M. X is exports of US
goods to Barbados; M is imports of Barbados
goods by US; Xn is net exports. Tippler's
investigations have yielded the following
information: Variable Mean St Dev
Imports (M) 200 30
Exports (X) 75 25

Net Exports, Xn
 According to Tippler, what is expected net exports?
E(Xn)= E(X) E(M) = 75-200 = 125
What is the variance of net exports, assuming X
and M are independent?
V(Xn)= V(X M) = V(X) + V(M) = 252 + (30)2
=1525
Are X and M independent?
Tippler discovered that the correlation coefficient
between X and M is -0.50. Does this change the
variance in the previous question? If so, by how
much? If not, why not?

Questions
r = 0.50
Yes
If r = 0.50
= =

= . =
The covariance term: =

Total variance: + =
Standard Deviation of Xn= SQRT(2275) = $47.70

So, are X & M Related?