MATH 2510

Rolf Poulsen
November 17, 2010

Expectations, Non-Linear Functions, and

Log-Normal Random Variables
Let Y be a random variable with probability density function ψ, and let f be
a function. Then Z
E(f (Y )) = f (y)ψ(y)dy
R
If Y is discrete the -symbol on the right hand side should be interpreted as
a sum, if Y continuous it means the usual integral. This is sometimes called
“the rule of the unconscious statistician.”

In general:
E(f (Y )) 6= f (E(Y ))
If f linear, then equality holds. Otherwise, you are ill advised to assume that
it does. In case f is convex, we have E(f (Y )) ≥ f (E(Y )) with strict inequality
unless in degenerate cases. This is known as Jensen’s Inequality.

Saying/assuming that X ∼ N (µ, σ 2 ), is saying that the probability density

function of X is
1 (x−µ)2
φ(x) = √ e− 2σ2 .
2πσ
It is in fact a bit tricky to show that the φ above integrates to 1 as a density
must — but it does, and all is well.

2 /2
Theorem 1: If Z ∼ N (0, σ 2 ) then E(eZ ) = eσ .

Proof: By the rule of the unconscious statistician

Z ∞
1 z2
Z
E(e ) = ez √ e− 2σ2 dz
−∞ 2πσ
In the exponent let’s add and subtract σ 2 /2; this is known as completing the
square. Moving things around and rewriting this leads to
Z ∞  Z ∞ 
Z σ 2 /2 1 2
−σ 2 /2+z− z 2 σ 2 /2 1 −−
(z−σ 2 )2
E(e ) = e √ e 2σ dz = e √ e 2σ 2 dz .
2πσ −∞ 2πσ −∞

1
The term in the square bracket looks nasty, but upon closer inspection is just
the integral on the density of a N (σ 2 , σ 2 )-variable, and hence a simply a con-
voluted way of writing 1 — and we’re done.

2 /2
Corollary: If X ∼ N (µ, σ 2 ) then E(eX ) = eµ+σ .

We say that Z is log-normally distributed if ln Z ∼ N (µ, σ 2 ) and as shorthand

we write Z ∼ LN (µ, σ 2 ).

2 /2
Theorem 2 : If Z ∼ LN (µ, σ 2 ) then E(Z) = eµ+σ and
2 2
Var(Z) = e2µ+σ (eσ − 1).

Proof: We may write Z = eX , where X ∼ N (µ, σ 2 ). The part first then follows
directly from the Corollary. To calculate the variance, let’s first write

E(Z 2 ) = E((eX )2 ) = E(e2X ).

But 2X ∼ N (2µ, 4σ 2 ) as multiplying a normal variable by a scalar produces

a new normal variable, and the square of the scalar multiplies the variance.
Applying the corollary again we get that
2
E(Z 2 ) = e2µ+2σ .

The final expression follows from the definition Var(Z) = E(Z 2 ) − [E(Z)]2 .

The results in Theorem 2 are used repeatedly and “without much warning” in
the Examiners’ Reports for CT1 exams (i.e. in the official solutions.)