Statistics for Business and Economics

Ninth Edition, Global Edition

Chapter 4
Discrete Random
Variables and
Probability
Distributions

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Chapter Goals
After completing this chapter, you should be
able to:
• Interpret the mean and standard deviation for a discrete
random variable
• Use the binomial probability distribution to find probabilities
• Describe when to apply the binomial distribution
• Use the hypergeometric and Poisson discrete probability
distributions to find probabilities
• Explain covariance and correlation for jointly distributed
discrete random variables
• Explain an application to portfolio investment
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Section 4.1 Random Variables
• Random Variable
– Represents a possible numerical value from
a random experiment

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Discrete Random Variable
• Takes on no more than a countable number of
values
Examples:

– Roll a die twice

Let 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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Continuous Random Variable
• Can take on any value in an interval
– Possible values are measured on a continuum

Examples:
– Weight of packages filled by a mechanical filling
process
– Temperature of a cleaning solution
– Time between failures of an electrical component

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Section 4.2 Probability Distributions
for Discrete Random Variables (1 of 2)
Let X be a discrete random variable and x be one of
its possible values
• The probability that random variable X takes
specific value x is denoted P ( X = x ) Probability Mass
Function (PMF)
• The probability distribution function of a random
variable is a representation of the probabilities for
all the possible outcomes.
– Can be shown algebraically, graphically, or with
a table

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Section 4.2 Probability Distributions
for Discrete Random Variables (2 of 2)
Experiment: Toss 2 Coins. Let X = # heads.
Show P ( x ) , i.e., P ( X = x ) , for all values of x 

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Probability Distribution Required
Properties
• 0  P ( x)  1 for any value of x

• The individual probabilities sum to 1;

 P ( x) = 1
x

(The notation indicates summation over all possible x values)

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Cumulative Probability Function (1 of 2)
CDF
• The cumulative probability function, denoted F ( x0 ),
shows the probability that X does not exceed the value x0

F ( x0 ) = P ( X  x0 )
Where the function is evaluated at all values of x0

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Cumulative Probability Function (2 of 2)
Example: Toss 2 Coins. Let X = # heads.

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Derived Relationship
The derived relationship between the probability
distribution and the cumulative probability distribution
• Let X be a random variable with probability distribution P ( x )
and cumulative probability distribution F ( x0 ) . Then

F ( x0 ) =  P ( x)
x  x0

(the notation implies that summation is over all

possible values of x that are less than or equal to x0 )

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Derived Properties
Derived properties of cumulative probability distributions
for discrete random variables
• Let X be a discrete random variable with cumulative
probability distribution F ( x0 ) . Then

1. 0  F ( x0 )  1 for every number x0

2. For x0  x1 , then F ( x0 )  F ( x1 )

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Section 4.3 Properties of Discrete
Random Variables
• Expected Value (or mean) of a discrete random
variable X:
E  X  =  =  xP ( x )
x

• Example: Toss 2 coins,

x = # of heads,
compute expected value of x:

E ( x ) = ( 0  .25 ) + (1  .50 ) + ( 2  .25 )

= 1.0
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Variance and Standard Deviation
• Variance of a discrete random variable X

 = E ( X −  ) = ( x −  ) P( x)
 
2 2 2

  x
Can also be expressed as

 2 = E  X 2  −  2 =  x 2 P ( x ) −  2
x

• Standard Deviation of a discrete random variable X

=  = ( x −  ) P ( x)
2 2

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Standard Deviation Example
• Example: Toss 2 coins, X = # heads, compute
standard deviation (recall E  X  = 1)

= ( x −  ) P ( x)
2

= ( 0 − 1) (.25 ) + (1 − 1) (.50 ) + ( 2 − 1) (.25 ) =

2 2 2
.50 = .707

Possible number of heads

= 0, 1, or 2

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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

E  g ( X )  =  g ( x )P ( x )
x

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Linear Functions of Random
Variables

• Let random variable X have mean x and variance  2
x

• Let a and b be any constants.

• Let Y = a + bX
• Then the mean and variance of Y are
Y = E ( a + bX ) = a + b x

 2Y = Var ( a + bX ) = b 2 2 x
• so that the standard deviation of Y is

Y = b  x

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Example

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Example

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Properties of Linear Functions of
Random Variables
• Let a and b be any constants.
• a) E ( a ) = a and Var ( a ) = 0
i.e., if a random variable always takes the value a, it will
have mean a and variance 0

• b) E ( bX ) = b x and Var ( bX ) = b 2 2 x
i.e., the expected value of b  X is b  E ( x )

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Probability Distributions

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Section 4.4 The Binomial Distribution

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Bernoulli Distribution
• Consider only two outcomes: “success” or “failure”
• Let P denote the probability of success
• Let 1 − P be the probability of failure
• Define random variable X:
x = 1 if success, x = 0 if failure
• Then the Bernoulli probability distribution is

P ( 0 ) = (1 − P ) and P (1) = P

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Mean and Variance of a Bernoulli
Random Variable
• The mean is  x = P
 x = E  X  =  xP ( x ) = ( 0 )(1 − P ) + (1) P = P
x

• The variance is  x = P (1 − P )
2

 = E ( X − x ) =  ( x − x ) P ( x )
 
2 2 2
x   x

= ( 0 − P ) (1 − P ) + (1 − P ) P = P (1 − P )
2 2

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Developing the Binomial Distribution
• The number of sequences with x successes in n
independent trials is:
n!
C x = x!( n − x )!
n

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
• Order is not important

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Binomial Probability Distribution
• A fixed number of observations, n
– e.g., 15 tosses of a coin; ten light bulbs taken from a warehouse
• 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
• Constant probability for each observation
– e.g., Probability of getting a tail is the same each time we toss the
coin
• Observations are independent
– The outcome of one observation does not affect the outcome of
the other
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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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The Binomial Distribution
Probability Mass Function (PMF)
n!
P( x) = P (1 − P )
x n− x

x !( n − x )!

P ( x ) = probability of x successes in n
trials, with probability of success
P on each trial Example: Flip a coin four times,
x = number of ‘successes’ in sample, let x = # heads:
( x = 0, 1, 2, , n) n=4
n = sample size (number of P = 0.5
independent trials or observations)
1 − P = (1 − 0.5 ) = 0.5
P = probability of “success”
x = 0, 1, 2, 3, 4

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Example 1: 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
n!
P ( x = 1) = P (1 − P )
x n− x

x !( n − x )!
5!
( 0.1) (1 − 0.1)
1 5 −1
=
1!( 5 − 1)!
= ( 5 )( 0.1)( 0.9 )
4

= .32805

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Shape of 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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Mean and Variance of a Binomial
Distribution
• Mean
 = E ( x ) = nP

• Variance and Standard Deviation

 2 = nP (1 − P )
 = nP (1 − P )
Where n = sample size
P = probability of success
(1 − P) = probability of failure

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Binomial Characteristics
Examples

 = nP = ( 5 )( 0.1) = 0.5
 = nP (1 − P ) = ( 5 )( 0.1)(1 − 0.1)
= 0.6708

 = nP = ( 5 )( 0.5 ) = 2.5

 = nP (1 − P ) = ( 5 )( 0.5 )(1 − 0.5 )

= 1.118

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Using Binomial Tables

Examples:
𝑛 = 10, 𝑥 = 3, 𝑃 = 0.35: 𝑃 𝑥 = 3|𝑛 = 10, 𝑝 = 0.35 = .2522

𝑛 = 10, 𝑥 = 8, 𝑃 = 0.45: 𝑃 𝑥 = 8|𝑛 = 10, 𝑝 = 0.45 = .0229

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Section 4.5 The Poisson Distribution
(1 of 3)

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Section 4.5 The Poisson
Distribution (2 of 3)
• The Poisson distribution is used to determine the probability
of a random variable which characterizes the number of
occurrences or successes of a certain event in a given
continuous interval (such as time, surface area, or length).

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Section 4.5 The Poisson
Distribution (3 of 3)
• Assume an interval is divided into a very large number of
equal subintervals where the probability of the
occurrence of an event in any subinterval is very small.
Poisson distribution assumptions
1. The probability of the occurrence of an event is constant
for all subintervals.
2. There can be no more than one occurrence in each
subinterval.
3. Occurrences are independent; that is, an occurrence in
one interval does not influence the probability of an
occurrence in another interval.
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Poisson Distribution Function (PMF)
The expected number of events per unit is the parameter 
(lambda), which is a constant that specifies the average
number of occurrences (successes) for a particular time
and/or space
−
e  x
P ( x) =
x
where:
P ( x ) = the probability of x successes over a given time or space, given 
 = the expected number of successes per time or space unit,   0

e = base of the natural logarithm system (2.71828 )

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Poisson Distribution Characteristics
Mean and variance of the Poisson distribution

• Mean
x = E  X  = 
• Variance and Standard Deviation

  (  ) =
2
= −
2
E X
x  x

= 
where  = expected number of successes per time or space unit

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Using Poisson Tables

Example: Find 𝑃 𝑋 = 2 if 𝜆 = .50

−0.50
( 0.50 )
− 2
e  e X
P ( X = 2) = = = .0758
X 2
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Graph of Poisson Probabilities
Graphically:

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Poisson Distribution Shape
• The shape of the Poisson Distribution depends on
the parameter  :

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Poisson Approximation to the
Binomial Distribution
Let X be the number of successes from n independent trials,
each with probability of success P. The distribution of the
number of successes, X , is binomial, with mean nP.
If the number of trials, n, is large and nP is of only moderate
size (preferably nP  7 ), this distribution can be approximated
by the Poisson distribution with  = nP. The probability
distribution of the approximating distribution is
− nP
( nP )
x
e
P( x) = for x = 0,1, 2,...
x

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Section 4.6 The Hypergeometric
Distribution (1 of 2)

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Section 4.6 The Hypergeometric
Distribution (2 of 2)
• “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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 Hypergeometric Probability
Distribution
S!

( N − S )
x !( S − x ) ( n − x )( N − S − n + x )
S N −S

P ( x) = C x C n− x
=
N
N!
C
n!( N − n )
n

Where N = population size

S = number of successes in the population
N − S = number of failures in the population
n = sample size
x = number of successes in the sample
n − x = number of failures in the sample

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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

( 6 )( 6 )
S N −S 4 6

P ( x = 2) = C C x
N
n− x
=C C 2
10
1
= = 0.3
C C 120
n 3

The probability that 2 of the 3 selected computers have illegal software

loaded is 0.30, or 30%.
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Hypergeometric Probability
Distribution

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Section 4.7 Jointly Distributed
Discrete Random Variables
• A joint probability distribution is used to express the
probability that simultaneously X takes the specific value
x and Y takes the value y, as a function of x and y

P ( x, y ) = P ( X = x  Y = y )

• The marginal probability distributions are

P ( x ) =  P ( x, y ) P ( y ) =  P ( x, y )
y x

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Properties of Joint Probability
Distributions
Properties of Joint Probability Distributions of Discrete
Random Variables
• Let X and Y be discrete random variables with joint
probability distribution P ( x, y )

1. 0  P ( x, y )  1 for any pair of values x and y

2. the sum of the joint probabilities P ( x, y )
over all possible pairs of values must be 1

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Conditional Probability Distribution
• The conditional probability distribution of the random
variable Y expresses the probability that Y takes the value
y when the value x is specified for X.

P ( x, y )
P( y | x) =
P ( x)

• Similarly, the conditional probability function of X, given

Y = y is:
P ( x, y )
P( x | y) =
P( y)

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Independence
• The jointly distributed random variables X and Y are said
to be independent if and only if their joint probability
distribution is the product of their marginal probability
functions:
P ( x, y ) = P ( x ) P ( y )

for all possible pairs of values x and y

• A set of k random variables are independent if and only if

P ( x1 , x2 , , xk ) = P ( x1 ) P ( x2 )  P ( xk )

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Conditional Mean and Variance
• The conditional mean is

Y | X = E Y | X  =  ( y | x )P ( y | x )
y

• The conditional variance is

 (
= E  Y − Y | X ) |X = (  y−
) | x  P ( y| x )
2 2 2
Y|X    Y|X 
y

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Covariance
• Let X and Y be discrete random variables with means
 X and Y
• The expected value of ( X −  X )(Y − Y )
is called the covariance between X and Y
• For discrete random variables
Cov ( X , Y ) = E ( X −  X )(Y − Y )  =  ( x −  x ) ( y −  y ) P ( x, y )
x y

• An equivalent expression (computationally easy) is

Cov ( X , Y ) = E ( XY ) −  x  y =  xyP ( x, y ) −  x  y
x y

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Correlation
• The correlation between X and Y is:
Cov ( X , Y )
 = Corr ( X , Y ) =
 XY
• −1    1
•  = 0  no linear relationship between X and Y
•   0  positive linear relationship between X and Y
– when X is high (low) then Y is likely to be high (low)
–  = +1  perfect positive linear dependency
•   0  negative linear relationship between X and Y
– when X is high (low) then Y is likely to be low (high)
–  = −1  perfect negative linear dependency
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 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
– The reason a covariance of 0 does not necessarily
imply statistical independence is that covariance is
designed to measure linear association, and it is
possible that this quantity may not detect other
types of dependency.
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Covariance and Independence
Counterexample

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Portfolio Analysis (1 of 2)
• 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

W = aX + bY
(a is the number of shares of stock A,
b is the number of shares of stock B)

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Portfolio Analysis (2 of 2)
• The mean value for W is

W = E W  = E  aX + bY 
= a  X + bY
• The variance for W is

 =a  +b  + 2abCov ( X , Y )
2 2 2 2 2
W X Y

or using the correlation formula

 =a  +b  + 2abCorr ( X , Y ) X  Y
2 2 2 2 2
W X Y

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 Intuition: Why incorporating COV
• Variance (Uncertainty) is additive. If X1 and X2 are
uncorrelated, the uncertainty in their sum is the sum of their
uncertainties: Var(X1+X2)=Var(X1)+Var(X2) But what if they
are correlated? Two things can happen.
(Think about how to generate W=X1+X2)

• If they are positively correlated this will increase the

uncertainty since this makes it more likely that observations of
the two variables will pull away from the means in the same
direction, pulling the sum even farther away from its mean.

• If they are negatively correlated, they will tend to pull in

opposite directions. This will lead to a cancellation of errors
whereby the sum will be even closer to its average than either
of the variables are close to theirs.
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Intuition: Why incorporating COV
• The covariance term Cov(X1,X2) shows how the
correlation between the variables effects the overall
uncertainty.

• Similar intuitions hold with more than 2 variables.

• Every pair of variables {Xi,Xj} can either increase

or decrease the overall uncertainty of the sum.

• By adding all such covariances together you get the

net change of uncertainty from all such pairs.

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Intuition: Why incorporating COV
https://math.stackexchange.com/questions/2698210/in
tuition-on-variance-of-linear-combination-of-variables

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More General Case

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Example 2: Investment Returns
Return per $1,000 for two types of investments

E ( x ) =  x = ( −25 )(.2 ) + ( 50 )(.5 ) + (100 )(.3 ) = 50

E ( y ) =  y = ( −200 )(.2 ) + ( 60 )(.5 ) + ( 350 )(.3 ) = 95

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Computing the Standard Deviation
for Investment Returns

x = ( −25 − 50 ) ( 0.2 ) + ( 50 − 50 ) ( 0.5 ) + (100 − 50 ) ( 0.3 )

2 2 2

= 43.30
y = ( −200 − 95 ) ( 0.2 ) + ( 60 − 95 ) ( 0.5 ) + ( 350 − 95 ) ( 0.3 )
2 2 2

= 193.71
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Covariance for Investment Returns

Cov ( X , Y ) = ( −25 − 50 )( −200 − 95 )(.2 ) + ( 50 − 50 )( 60 − 95 )(.5 )

+ (100 − 50 )( 350 − 95 )(.3 )
= 8250

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Portfolio Example:
Linear Combination
Investment X:  x = 50  x = 43.30
Investment Y:  y = 95  y = 193.21
Covariance  xy = 8250
Suppose 40% of the portfolio (P) is in Investment X and 60%
is in Investment Y:
E ( P ) = .4 ( 50 ) + (.6 )( 95 ) = 77

P = (.4 ) ( 43.30 ) + (.6 ) (193.21) + 2 (.4 )(.6 )(8250 )

2 2 2 2

= 133.04
The portfolio return and portfolio variability are between the values for
investments X and Y considered individually
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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 8250 indicates that the two
investments are positively related and will vary in
the same direction

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Chapter Summary
• Defined discrete random variables and probability
distributions
• Discussed the Binomial distribution
• Reviewed the Poisson distribution
• Discussed the Hypergeometric distribution
• Defined covariance and the correlation between
two random variables
• Examined application to portfolio investment

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