Department of Economics

Yale University

Econ 131a
Econometrics & Data Analysis I
Fall 2010

Solutions

ECON 131: Econometrics and Data Analysis I

Problem Set #1

Answers to Assignment #1
1. (Airline Safety). We will solve this problem using probability tables. The attributes for the probability table are cause of emergency landing and occurrence
of fatalities, and the table is as follows:

Occurrence of
fatalities

Fatalities
No fatalities

Cause of emergency landing

Equipment
Not Equipment
Malfunction
Malfunction
0.1 * 0.15 = 0.015 0.085
0.585
0.315
0.6
0.4

0.1
0.9

Please note that the third bullet-point statement in the problem is a conditional
probability, which we use to calculate the joint probability 0.015 in the upper leftcell.
(a) The quotient rule states that
P rob(one or more fatalities |not equipment malfunction)
P rob(one or more fatalities and not equipment malfunction)
=
P rob(not equipment malfunction)
0.085
=
= 0.2125
0.4
(b) Here we must check whether the joint probability for equipment malfunction
and one or more fatalities is equal to the product of the marginal probabilities.
From the table, Prob(equipment malfunction and one or more fatalities) = 0.015 and
the product of the joint probabilities Prob(equipment malfunction) * Prob(one or
more fatalities)=0.6 * 0.1= 0.06. So, Prob(equipment malfunction and one or more
fatalities) 6= Prob(equipment malfunction)*Prob(one or more fatalities), and hence
the two events are not independent.
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(c) From the above table: Prob(equipment malfunction and one or more fatalities)
= 0.015 (it is the probability in the upper left cell)
(d) From the table: Prob(not equipment malfunction and no fatalities)= 0.315 (it is
the probability in the lower right cell).
2. (Business Week Poll) In this problem we are given a conditional probability and a
marginal probability and we are asked to find a joint probability. Specifically, we are
given that Prob(female executive has been harassed) = 0.27 and that Prob(female
executive reports harassment female executive has been harassed) = 0.25. We are
asked to find Prob(female executive reports harassment and female executive has
been harassed). By the product rule:
P rob(female executive reports harassment and female executive has been harassed)
= P rob(female executive has been harassed)
P rob(female executive reports harassment female executive has been harassed)
= 0.27 0.25 = 0.0675.
Remark. This is called the reporting bias problem; if people who have been the
victims of a crime tend not to report it, the reported incidence (in this case about
6.75%) may seriously understate the true incidence (in this case 27%).
3. (Student Background). The best way to approach this problem is using the
following probability tree:
Event

Probability

Engineering
Biz School Student with Engineering
Background

0.0666

Biz School Student with Social

Science Backgorund

0.0432

Biz School Student with Other

Background

0.0702

0.37

GSB Student

Social Science

0.18

0.24

Other

0.39

Other Grad Student

Other Graduate Student

0.82

0.82

There are two types of uncertainties for a randomly picked grad student: (a) whether
or not he or she is a business school student, and (b) for a business school student,
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whether he or she is from an engineering background, a social science background, or

other. So in this tree we represent the first form of uncertainty using the first chance
node, and the second using the second chance node, and the probabilities placed on
the tree are extracted from the statement of the problem.
(a) Here we are asked to determine the Prob(social science background and biz school
student). From the tree it follows that the event social science background and
biz school student corresponds to the middle upper branch of the tree. Therefore,
Prob(social science background and biz school student) = 0.0432.
(b) Here we want to find the probability that a grad student is neither a biz school
student with a social science background nor a biz school student with an engineering
background. From the tree, it follows that this event corresponds to the branches
other graduate student (lowest branch) and other biz school student (second lowest
branch). So, Prob(neither biz school with social science background nor biz school
with engineering background ) = 0.0702 + 0.82 = 0.8902.
Note. For the math jocks among you, here is a solution using the five probability
rules directly: Let A1 denote engineering background, A2 denote social science background, and let B be the event biz school student. We are given Prob(A1|B)=0.37,
Prob(A2|B)=0.24, Prob(B)=0.18.
(a) Prob(A2 and B)= Prob(A2|B)*Prob(B) =0.24*0.18 = 0.0432.
(b) Prob(not (A1 and B) nor (A2 and B))= 1-P[(A1 and B) or (A2 and B)] = 1[Prob(A1 and B) + Prob(A2 and B)] = 1-0.0666-0.0432=0.8902.
Note Prob(A2 and B) is calculated in the same manner that we used in (a) to calculate
Prob(A1 and B).
4. We will solve this problem using probability trees.
First note that there are two uncertainties here: (a) Whether the customer buys
a 2-door or a 4-door; and (b) whether the customer buys on credit or pays cash
up front. We are also given the marginal probability of buying a 2-door, and the
conditional probability of buying on credit given that the consumer is buying a 2door. Moreover we are given the conditional probability of paying up front given that
the consumer is buying a sedan. So we create a tree with two set of nodes: the first
node represents whether the consumer buys a 2-door or a 4-door, and the second set
of nodes represents whether the consumer buys on credit or pays cash up front. The
car selection node comes first because we know the marginal probabilities.

The tree looks like this:

Event

Probability

Credit
2-door

2-door on credit

0.3

2-door, up front

0.1

4-door, on credit

0.12

4-door, up front

0.48

0.75
0.4
Up Front
0.25

Credit
4-door

0.2
0.6
Up Front
0.8

(a) From the probability tree: Prob(buy on credit) = 0.3 + 0.12 = 0.42.
(b) Here we are asked to find Prob(buy 2-door| pay up front). By the quotient rule:
Prob(Buy 2-door and pay up front)
Prob(pay up front)
0.1
=
= 0.172.
0.58

Prob(Buy 2-door| pay up front) =

Remark: You can also do this problem using probability tables. We used a probability tree for continuity with problem 5.

5. In order to solve this problem we expand the probability tree from question 4 to
include one more set of branches which represent whether the consumers who buy on
credit will default or not. The tree looks as follows:
Event

Probability

default

credit

2-door, on credit,
default

0.18

2-door, on credit,
no default

0.12

0.6

0.75
No default
2-door
0.4
0.4
up front
2-door, up front

0.1

0.25

default

credit

4-door, on credit,
default

0.036

4-door, on credit,
no default

0.084

0.3
0.2
No default

4-door
0.7
0.6
up front

4-door, up front

0.48

0.8

(a) From the probability tree: Prob(buy on credit and default) = 0.18 + 0.036 =
0.216.
(b) The tricky part here is to recognize that the question asks for the probability
Prob(default| buy on credit). Now using the quotient rule and the probability tree
we get: Prob(default| buy on credit) = Prob(default and buy on credit) / Prob(buy
on credit) = 0.216
= 0.514; the marginal probability 0.42 is from question 4(a).
0.42
6. (HIV Testing). The statement of the problem gives the following probabilities:
Prob(Infected Donor) = 0.0001,
Prob(Negative Test| Infected Donor) = 0.01,
Prob(Positive Test| Not-Infected Donor) = 0.001,
and it asks to determine the Prob(Positive Test) and the Prob(Not-Infected| Positive
Test). This can be done using a probability table with two attributes: infection status
(infected or not-infected) and test outcomes (positive or negative). The Table is as
follows:

Test
Outcomes

Infection Status
Infected
Positive 0.0001*0.99=0.000099
Negative 0.000001
0.0001

Not-Infected
0.9999*0.001=0.0009999
0.9989001
0.9999

0.0010989
0.9989011
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(a) It follows from this Table that Prob(Positive Test) = 0.0010989.

(b) To determine the Prob(Not-Infected| Positive Test), we use the quotient rule and
the results in the above Table:
Prob(Not-Infected AND Positive Test)
Prob(Positive Test)
0.0009999
=
= 0.90991;
0.0010989

Prob(Not-Infected| Positive Test) =

this answer is correct within 5 decimal points.

Note: This problem was motivated by a paper on HIV testing (Operations Research,
Vol. 44, pp. 543-569). The numbers reflect the tests used in the US in the late 1990s,
and they were provided by Centers for Disease Control. Newer HIV tests have higher
accuracy.

Department of Economics
Department
Yale
Universityof Economics
Yale University

Problem 7:

Econ 131a
Econ 131a
Econometrics & Data Analysis
I
Econometrics & Data
Analysis
Fall
2010 I
Fall 2010

Answers to Assignment #2
Answers to Assignment #2

1. This problem is very similar to the problems solved in the Variance Associates
This
problema is
veryapplication
similar to the
problems
solved
in the Variance
case1.and
it involves
direct
of the
mechanics
of random
variables.Associates
case and it involves a direct application of the mechanics of random variables.
(a) We can compute the expected value for the total number of orders as
(a) We can compute the expected value for the total number of orders as
E(Total Orders) = E(Orders from Client 1 + Orders from Client 2)
E(Total Orders) = E(Orders from Client 1 + Orders from Client 2)
= E(Orders from Client 1) + E(Orders from Client 2).
= E(Orders from Client 1) + E(Orders from Client 2).
Now,
Now,
E(Orders
from Client 1) = 0.1(0) + 0.2(50) + 0.3(200) + 0.4(300) = 190,
E(Orders from Client 1) = 0.1(0) + 0.2(50) + 0.3(200) + 0.4(300) = 190,
and and

E(Orders
fromfrom
Client
2) =2)0.2(0)
+ 0.2(100)
+ 0.6(150)
= 110.
E(Orders
Client
= 0.2(0)
+ 0.2(100)
+ 0.6(150)
= 110.

Therefore
Therefore

E(Total
Orders)
= 190
+ 110
= 300.
E(Total
Orders)
= 190
+ 110
= 300.
We We
cannot
compute
the the
standard
deviation
because
we dont
know
whether
the the
two two
cannot
compute
standard
deviation
because
we dont
know
whether
orders
are
independent.
orders are independent.
(b) (b)
Since
we are
toldtold
thatthat
the the
orders
fromfrom
the the
two two
clients
are are
independent,
we can
Since
we are
orders
clients
independent,
we can
nownow
compute
the
variance
(and
standard
deviation)
of
the
total
number
of
orders
compute the variance (and standard deviation) of the total number of orders
using
the
formula:
using the
formula:
Var(Total
Orders)
= Var(Orders
fromfrom
Client
1) +1)Var(Orders
fromfrom
Client
2) 2)
Var(Total
Orders)
= Var(Orders
Client
+ Var(Orders
Client
Using
the the
formula
fromfrom
class,
Using
formula
class,
2
2
2
2
2
Var(Orders
Client
= 0.1(0190)190)
+ 0.2(50190)190)
+ 0.3(200190)190)
Var(Orders
fromfrom
Client
1) 1)
= 0.1(0
+ 0.2(50
+ 0.3(200
+ 2+
2
0.4(300190)190)
0.4(300
=2 =
= 12400,
= 12400,

and and
2
2
2
2
2
2
Var(Orders
Client
= 0.2(0
+ 0.2(100
+ 0.6(150
= 3400.
Var(Orders
fromfrom
Client
2) =2)0.2(0
110)110)
+ 0.2(100
110)110)
+ 0.6(150
110)110)
= 3400.

Therefore,
Var(Total Orders) = 12400 + 3400 = 15800,
and
SD(Total orders) =

15800 = 125.70.

The expected value is the same as before; we dont need independence to argue
E(X + Y ) = E(X) + E(Y ).
In this part, we must find the Prob(Total Orders 100). Because we assume that the
orders from the two clients are independent, we can compute the joint probabilities
by multiplying the marginal probabilities. This gives the following probability table:

Client 1

0
50
200
300

0
0.02
0.04
0.06
0.08
0.2

Client 2
100 150
0.02 0.06
0.04 0.12
0.06 0.18
0.08 0.24
0.2 0.6

0.10
0.20 .
0.30
0.40

By the addition rule:

Prob(Total orders 100) = 0.02 + 0.02 + 0.04
= 0.08
(c) Using the formula for the covariance we can write
Cov(Orders from Client 1, Orders from Client 2) =
0.05(0 190)(0 110) + 0.04(0 190)(100 110) + 0.01(0 190)(150 110)+
0.06(50 190)(0 110) + 0.06(50 190)(100 110) + 0.08(50 190)(150 110)+
0.06(200 190)(0 110) + 0.09(200 190)(100 110) + 0.15(200 190)(150 110)+
0.03(300 190)(0 110) + 0.01(300 190)(100 110) + 0.36(300 190)(150 110) =
2800.
The expected value of the Total Orders is 300 (as before), and
Var(Total Orders) =
= Var(Orders from Client 1 + Orders from Client 2)
= Var(Orders from Client 1) + Var(Orders from Client 2)+
+2Cov(Orders from Client 1, Orders from Client 2)
= 12400 + 3400 + 2(2800) = 21, 400,

and the standard deviation is

2
21, 400=146.29.

Finally, Prob(Total Orders 200) = 0.05 + 0.04 + 0.01 +0.06 + 0.06 + 0.08 + 0.06
=0.36.
2. This problem is a simple application of binomial distributions, expected values
and variances.
Let X denote the total number of callers that either got a busy signal or hang up.
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Then X is a binomial random variable with n = 2000 and p = 0.032; because X is
Binomial, it follows that E[X] = np and Var(X) = np(1 p).

8. (Calculating Portfolio Variances.) In this problem, we are asked to find the expected
value and variance of a portfolio of stocks. To do that we will repeatedly use the
formula for the expected value of a sum of random variables, and the formula for the
variance of the sum of random variables.
(a) To compute the expected value, we express the value of the portfolio in terms of
the value of the Apple shares, the value of the Google shares, and the value of the
Facebook shares. Mathematically, let PAAPL be the price of one share of Apple one
month from now, PGOOG be the price of one share of Google one month from now, and
PFB be the prices of one share of Facebook one month from now. Then, the total value
of Marges portfolio in one month is:
Total Value of Portfolio=200 PAAPL + 100 PGOOG + 50 PFB.
This now implies that:
E(Total Value of Portfolio) = E(200 PAAPL + 100 PGOOG + 50 PFB)
= (200 $120 + 100 $60 + 50 $60)
= $24, 000 + $6, 000 + $3, 000 = $33, 000.
(b) To calculate the standard deviation, we will first need to calculate the variance in
the total value of the portfolio. In the process we will use the following fact (which
generalizes Fact 2 in the Sums of Random Variables note). The variance of a sum of
three random variables equals the sum of the variances of the three plus the 2 times the
covariance of each pair of random variables. The trick in this problem was to derive
this formula by applying the formula for a variance of a sum of two random variables
twice (in succession).
So, to get the variance of Marges portfolio, we have:
Var(Value of Portfolio) = Var(200 PAAPL + 100 PGOOG + 50 PFB) =
Var(200PAAPL)+Var(100PGOOG)+Var(50PFB)+
2Cov(200PAAPL,100PGOOG)+2Cov(200PAAPL,50PFB)+ 2Cov(100PGOOG,50PFB)
= 40000Var(PAAPL)+10000Var(PGOOG)+2500Var(PFB)+40000Cov(PAAPL,PGOOG)
+20000Cov(PAAPL,PFB)+10000Cov(PGOOG,PFB)
= 40000 100 + 10000 64 + 2500 64 + 40000 (36) + 20000 24 + 1000019
= 4, 030, 000 (dollars)2
and the standard deviation = sqrt(4, 030, 000) = 2007.49 dollars.
Remark. You should go over this problem carefully and make sure that you
understand how and why the constants pull out from the expectations, variances and
covariances. Also, it is useful to remember that variances can never be negative, while
covariances can.
9

(c) For Marges sister, Maggie, the calculations are pretty much the same. It should
come as no surprise that the expected value of Maggies portfolio, one month from
now, is exactly the same as that of Marges portfolio = $ 33, 000 dollars. The variance
of Maggies portfolio, one month from now, is a little higher = $ 5, 230, 000 (dollars)2
and the corresponding standard deviation is $2286.92 dollars.
(d) There isnt very much difference between the performances of the two portfolios.
However, Marges portfolio gives the same expected return, with a slightly lower
standard deviation; that is, she exposes herself to less risk. In that sense, her portfolio
performs better than Maggies. You should be able to see why this is so.

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