Expected Value

Session#12
(Properties)

Expected Value of Random Variables

(Mathematical Expectation)

E [ h ( X )]   h ( x ) P ( x )
all x

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Expected Values of Discrete

A Fair Game
Random Variables
The mean of a probability distribution is a
measure of its centrality or location, as is the
Suppose you are playing a coin toss game in which you are
mean or average of a frequency distribution. It is paid $1 if the coin turns up heads and you lose $1 when the
a weighted average, with the values of the coin turns up tails. The expected value of this game is E(X) =
random variable weighted by their probabilities. 0 1 2

2.3
3 4 5
0. A game of chance with an expected payoff of 0 is called a
The mean is also known as the expected value (or expectation) of a random fair game.
variable, because it is the value that is expected to occur, on average.
x P(x) xP(x)
The expected value of a discrete random 0 0.1 0.0
variable X is equal to the sum of each 1 0.2 0.2 x P(x) xP(x)
value of the random variable multiplied by 2 0.3 0.6
-1 0.5 -0.50
3 0.2 0.6
its probability. 4 0.1 0.4 1 0.5 0.50 -1
0
1

  E ( X )   xP( x ) 5 0.1 0.5 1.0 0.00 = E(X)=

all x 1.0 2.3 = E(X) = 

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Expected Value of a Function of a Expected Value of a Function of a

Discrete Random Variables Discrete Random Variables
The expected value of a function of a discrete random variable X is: The expected value of a function of a discrete random variable X is:
E [ h ( X )]   h ( x ) P ( x ) E [ h ( X )]   h ( x ) P ( x )
all x all x

Example 3: Monthly sales of a certain Number Example 3: Monthly sales of a certain Number
product are believed to follow the given of items, x P(x) xP(x) h(x) h(x)P(x) product are believed to follow the given of items, x P(x) xP(x) h(x) h(x)P(x)
probability distribution. Suppose the 5000 0.2 1000 2000 400 probability distribution. Suppose the 5000 0.2 1000 2000 400
6000 0.3 1800 4000 1200 6000 0.3 1800 4000 1200
company has a fixed monthly production company has a fixed monthly production
7000 0.2 1400 6000 1200 7000 0.2 1400 6000 1200
cost of $8000 and that each item brings 8000 0.2 1600 8000 1600 cost of $8000 and that each item brings 8000 0.2 1600 8000 1600
$2. Find the expected monthly profit 9000 0.1 900 10000 1000 $2. Find the expected monthly profit 9000 0.1 900 10000 1000
h(X), from product sales. 1.0 6700 5400 h(X), from product sales. 1.0 6700 5400
E[ h( X )]   h( x) P ( x)  5400 Note: h (X) = 2X – 8000 where X = # of items sold E[ h( X )]   h( x) P ( x)  5400 Note: h (X) = 2X – 8000 where X = # of items sold
all x all x

The expected value of a linear function of a random variable is: The expected value of a linear function of a random variable is:
E(aX+b)=aE(X)+b E(aX+b)=aE(X)+b
In this case: E(2X-8000)=2E(X)-8000=(2)(6700)-8000=5400 In this case: E(2X-8000)=2E(X)-8000=(2)(6700)-8000=5400

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 Variance and Standard Deviation of Variance of a Linear Function of a
a Random Variable Random Variable
The variance of a linear function of a random variable is:
The variance of a random variable is the expected
V(a X b)  a2V( X)  a22
squared deviation from the mean:
Example 3
 2
 V ( X )  E [( X   ) 2 ]  a ll x
(x   ) 2 P(x )  2 V (X )

2 Number  E ( X 2 )  [ E ( X )]2
   
 E ( X 2 )  [ E ( X )] 2    x 2 P ( x )     x P ( x )  of items, x P(x) xP(x) x2 P(x)    
2

 a ll x   a ll x  5000 0.2 1000 5000000   x 2 P ( x )    xP ( x )

 all x   allx 
6000 0.3 1800 10800000
7000 0.2 1400 9800000  46500000  (6700 2 )  1610000
8000 0.2 1600 12800000
9000 0.1 900 8100000
The standard deviation of a random variable is the 1.0 6700 46500000
  SD( X )  1610000  1268 .86
V ( 2 X  8000 )  (2 2 )V ( X )

square root of its variance:   SD( X )  V ( X )  (4)(1610000 )  6440000

 ( 2 x 8000)  SD( 2 x  8000 )

 2 x  ( 2)(1268 .86 )  2537 .72

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Some Properties of Means and Some Properties of Means and

Variances of Random Variables Variances of Random Variables
The mean or expected value of the sum of random variables NOTE: E( X  X ... X )  E ( X )  E( X )  ... E ( X )
1 2 k 1 2 k
is the sum of their means or expected values:
( XY)  E( X Y)  E(X)  E(Y)  X  Y E(a X  a X ... a X )  a E( X )  a E( X ) ... a E ( X )
1 1 2 2 k k 1 1 2 2 k k
For example: E(X) = $350 and E(Y) = $200
E(X+Y) = $350 + $200 = $550 The variance of the sum of k mutually independent random
The variance of the sum of mutually independent random variables is the sum of their variances:
variables is the sum of their variances: V ( X  X ... X ) V ( X ) V ( X ) ...V ( X )
 2 ( X Y)  V ( X  Y)  V ( X ) V (Y)   2 X   2Y 1 2 k 1 2 k
if and only if X and Y are independent. and

For example: V(X) = 84 and V(Y) = 60 V(X+Y) = 144 V (a X  a X ... a X )  a2V ( X )  a2V ( X ) ... a2V ( X )
1 1 2 2 k k 1 1 2 2 k k

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Rules of Variance Problems:

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 1. The monthly sales at a shopping store have a mean $ 25000 and
standard deviation $ 4000. Profits are calculated by multiplying sales by
30% and subtracting a fixed cost of $ 6000. Find mean and standard
deviation of monthly profits.

2. An investor has decided to form a portfolio by putting 25% of his

money into McDonald’s stock and 75% into Cisco Systems stock. The
investor assumes that the expected returns will be 8% and 15%,
respectively, and that the standard deviations will be 12% and 22%,
respectively.
• Find the expected return on the portfolio.
• Compute the standard deviation of the returns on the portfolio assuming
that
• the two stocks’ returns are perfectly positively correlated.
• the coefficient of correlation is 0.5
• the two stocks are uncorrelated.

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