LECTURE 4
Discrete Variables
Lecturer: Nguyen Thi Thu Van
Email: van.nguyen@ueh.edu.vn
Content
Random variables
Probability distributions for discrete variables
Expected value - Variance of discrete variables
Expected value of a variable
Expected value of a function
Moments and Generating Moment Functions
Getting started by several simple examples
Tossing a fair coin three times
Possible events X = Heads
TTT
HTT,THT,TTH
HHT, HTH, THH
HHH
Tossing a fair coin four times
Possible events X = Heads
No Head
One Head
Two Heads
Three Heads
Four Heads
Then, what is a probability distribution?
A statistical function that can be depicted using
graphs or probability tables.
It describes the probability of different possible
values of a random variable.
Distributions come in many shapes with different
characteristics as defined by the mean, standard
deviation, skewness, and kurtosis.
Random Variables
A random variable is a function or rule that assigns
a numerical value to each outcome in the sample
space of a random experiment.
• A discrete random variable has a countable
number of distinct values (e.g. number of
classes you are taking).
• A continuous random variable produces
outcomes from a measurement (e.g. your
annual salary, waiting time for a bus, etc.)
Examples of Discrete Random Variable
Events Random Probability
Variable X = #B
GGG 0
GBG,GGB 1
GBB,BBG,BGB 2
BBB,BBB 3
Rolling a dice twice.
• Let X = the random variable which
represents the number of times 4 comes
up.
Then X could be 0, 1, or 2 times.
Tossing a coin 5 times.
• Let X = the random variable which
represents the number of heads.
Then X = 0, 1, 2, 3, 4, or 5.
Bernoulli Experiments
The success is merely meant to the event of interest.
Example of Continuous Random Variable
Probability Distributions
Random
Variables
Discrete Continuous
Random Variable Random Variable
Discrete Probability Distributions
Discrete Probability Density Function
Discrete Cumulative Distribution Function
Expected values of Discrete Random Variables
Expected value of a random variable
Expected value of a function
Expected Value of a Random Variable
Tossing a fair coin four times
Possible events X = Heads
No Head 0 0
One Head 1 0.25
Two Heads 2 0.75
Three Heads 3 0.75
Four Heads 4 0.25
For example, a lottery ticket has a grand prize of
$28 million. The probability of winning the grand
prize is .000000023. What is the expected value
for this game?
Expected value of a random variable
• indicates its central or average value,
meaning that it gives a measure of the center
of the distribution of the random variable. It is
an important summary value of the
distribution of the random variable.
• uses probability to tell us what outcomes to
expect in the long run.
How Expected Values are Used in Our Daily Life?
Life insurance
You take out a fire insurance policy on your
home. The annual premium is $300. In case of
fire, the insurance company will pay you
$200,000. The probability of a house fire in your
area is 0.0002. Suppose the insurance company
sells 100,000 of these policies. What can the
company expect to earn?
Raffles/Lotteries
In a state lottery, a single digit is drawn from
each of four containers. Each container has 10
balls numbered 0 through 9.
To play, you choose a 4-digit number and pay
$1. If your number is drawn, you win $5000. If
your number is not drawn, you lose your dollar.
What is the expected value for this game?
A child asks his parents for some money. The parents
make the following offers.
Father’s offer: The child flips a coin. If the coin
lands heads up, the father will give the child $20. If
the coin lands tails up, the father will give the child
nothing.
Mother’s offer: The child rolls a 6-sided die. The
mother will give the child $3 for each dot on the up
side of the die.
Which offer has the greater expected value?
Prof. Kahneman and Prof. Tversky are given two options of investing as follows.
Expected Value of a Function
How to Compute Expected Value of a Function
Probability function of X Probability function of Y
x 4 6 8 y 40 56 76
p(x) 0.5 0.3 0.2 p(y) 0.5 0.3 0.2
0 1 2 3
0.6 0.25 0.1 0.05
Variance vs. Standard Deviation
Example
σ (0 1)2 (.25) (1 1)2 (.50) (2 1)2 (.25) .50 .707
Possible number of heads
= 0, 1, or 2
13.5 15.9 19.1
0.2 0.5 0.3
Transformations of Random Variables
For any two random variables X and Y, one has
Expected value is a linear transformation.
If X and Y are independent then 0.
Variance
What are Applications of Variance?
In finance and investing, investors use variance to
assess the risk or volatility associated with assets
by comparing their performance within a portfolio
to the mean.
In accounting, variance is used to compare actual
financial results to budgeted or planned results.
and many more.
Example. Assume there is a portfolio that consists of
two stocks. Stock A is worth $50,000 and has a
standard deviation of 20%. Stock B is worth $100,000
and has a standard deviation of 10%.
The correlation between the two stocks is 0.85. Given
this, the portfolio weight of Stock A is 33.3% and 66.7%
for Stock B. The variance is calculated as follows.
Moments and Generating Moment Functions
Moments
What are Moments?
x 0 1 2 3
p(x) 0.1 0.2 0.3 0.4
Generating Moment Functions
Why it is needed?
Help in calculations moments.
Understand statistical distribution.
Example
If MGF exists and is the same for two distributions
then the two distributions are the same.
x 0 1 2
p(x) 0.7 0.2 0.1
x 0 1 2 3 4 5 6
0.04 0.2 0.34 0.2 0.15 0.04 0.03
How does MGF Produce Moments?
0 1 2
0.7 0.2 0.1
-- The End of Topic --
Thank You!
