Chap04 Probability BHBP Statistics

2002 Prentice-Hall, Inc.
Chap 4-1
Basic Probability and Discrete
Probability Distributions

Basic Probability and Discrete
Lecturer 3

Chap 4-2
Chapter Topics
Basic probability concepts
Sample spaces and events, simple probability, joint
probability
Conditional probability
Statistical independence, marginal probability
Bayess Theorem

Chap 4-3
Chapter Topics
The probability of a discrete random variable
Covariance and its applications in finance
Binomial distribution
Poisson distribution
Hypergeometric distribution

(continued)

Chap 4-4
Sample Spaces
Collection of all possible outcomes
e.g.: All six faces of a die:

e.g.: All 52 cards in a deck:

Chap 4-5
Events
Simple event
Outcome from a sample space with one
characteristic
e.g.: A red card from a deck of cards
Joint event
Involves two outcomes simultaneously
e.g.: An ace that is also red from a deck of
cards


Chap 4-6
Visualizing Events
Contingency Tables

Tree Diagrams
Red 2 24 26
Black 2 24 26
Total 4 48 52
Ace Not Ace Total
Full
Deck
of Cards
Red
Cards
Black
Cards
Not an Ace
Ace
Ace
Not an Ace

Chap 4-7
Simple Events
The Event of a Triangle
There are 5 triangles in this collection of 18 objects

Chap 4-8
The event of a triangle AND blue in color
Joint Events
Two triangles that are blue

Chap 4-9
Special Events
Impossible event
e.g.: Club & diamond on one card
draw
Complement of event
For event A, all events not in A
Denoted as A
e.g.: A: queen of diamonds
A: all cards in a deck that are
not queen of diamonds
+
+
Null Event

Chap 4-10
Special Events
Mutually exclusive events
Two events cannot occur together
e.g.: -- A: queen of diamonds; B: queen of clubs
Events A and B are mutually exclusive
Collectively exhaustive events
One of the events must occur
The set of events covers the whole sample space
e.g.: -- A: all the aces; B: all the black cards; C: all the
diamonds; D: all the hearts
Events A, B, C and D are collectively
exhaustive
Events B, C and D are also collectively
exhaustive
(continued)

Chap 4-11
Contingency Table
A Deck of 52 Cards
Ace
Not an
Ace
Total
Red
Black
Total
2 24
2 24
26
26
4 48 52
Sample Space
Red Ace

Chap 4-12
Full
Deck
of Cards
Tree Diagram
Event Possibilities
Red
Cards
Black
Cards
Ace
Not an Ace
Ace
Not an Ace

Chap 4-13
Probability
Probability is the numerical
measure of the likelihood
that an event will occur
Value is between 0 and 1
Sum of the probabilities of
all mutually exclusive and
collective exhaustive events
is 1
Certain
Impossible
.5
1
0

Chap 4-14
(There are 2 ways to get one 6 and the other 4)
e.g. P( ) = 2/36
Computing Probabilities
The probability of an event E:

Each of the outcomes in the sample space is
equally likely to occur
number of event outcomes
( )
total number of possible outcomes in the sample space

P E
X
T
=
=

Chap 4-15
Computing Joint Probability
The probability of a joint event, A and B:
( and ) = ( )
number of outcomes from both A and B
total number of possible outcomes in sample space
P A B P A B
=
E.g. (Red Card and Ace)
2 Red Aces 1

52 Total Number of Cards 26
P
= =

Chap 4-16
P(A
1
and B
2
) P(A
1
)
Total Event
Joint Probability Using
Contingency Table
P(A
2
and B
1
)
P(A
1
and B
1
)
Event
Total 1
Joint Probability
Marginal (Simple) Probability
A
1
A
2
B
1
B
2
P(B
1
) P(B
2
)
P(A
2
and B
2
) P(A
2
)

Chap 4-17
Computing Compound
Probability
Probability of a compound event, A or B:
( or ) ( )
number of outcomes from either A or B or both
total number of outcomes in sample space
P A B P A B =
=
E.g. (Red Card or Ace)
4 Aces + 26 Red Cards - 2 Red Aces

52 total number of cards
28 7

52 13
P
=
= =

Chap 4-18
P(A
1
)
P(B
2
)
P(A
1
and B
1
)
Compound Probability
(Addition Rule)
P(A
1
or B
1
) = P(A
1
) + P(B
1
) - P(A
1
and B
1
)
P(A
1
and B
2
)
Total Event
P(A
2
and B
1
)
Event
Total 1
A
1
A
2
B
1
B
2
P(B
1
)
P(A
2
and B
2
) P(A
2
)
For Mutually Exclusive Events: P(A or B) = P(A) + P(B)

Chap 4-19
Computing Conditional
Probability
The probability of event A given that event B
has occurred:
( and )
( | )
( )
P A B
P A B
P B
=
E.g.
(Red Card given that it is an Ace)
2 Red Aces 1
4 Aces 2
P
= =

Chap 4-20
Conditional Probability Using
Contingency Table
Black
Color
Type
Red Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52
Revised Sample Space
(Ace and Red) 2/ 52 2
(Ace | Red)
(Red) 26/ 52 26
P
P
P
= = =

Chap 4-21
Conditional Probability and
Statistical Independence
Conditional probability:

Multiplication rule:
( and )
( | )
( )
P A B
P A B
P B
=
( and ) ( | ) ( )
( | ) ( )
P A B P A B P B
P B A P A
=
=

Chap 4-22
Conditional Probability and
Statistical Independence
Events A and B are independent if

Events A and B are independent when the
probability of one event, A, is not affected by
another event, B
(continued)
( | ) ( )
or ( | ) ( )
or ( and ) ( ) ( )
P A B P A
P B A P B
P A B P A P B
=
=
=

Chap 4-23
Bayess Theorem
( )
( ) ( )
( ) ( ) ( ) ( )
( )
( )
1 1
|
|
| |
and

i i
i
k k
i
P A B P B
P B A
P A B P B P A B P B
P B A
P A
=
+--- +
=
Adding up
the parts
of A in all
the Bs
Same
Event

Chap 4-24
Bayess Theorem
Using Contingency Table
Fifty percent of borrowers repaid their loans. Out of those
who repaid, 40% had a college degree. Ten percent of
those who defaulted had a college degree. What is the
probability that a randomly selected borrower who has a
college degree will repay the loan?
( ) ( )
( )
.50 | .4 | .10 P R P C R P C R = = =
( )
| ? P R C =

Chap 4-25
Bayess Theorem
Using Contingency Table
( )
( ) ( )
( ) ( )
( ) ( )
( )( )
( )( ) ( )( )
|
|
| |
.4 .5
.2
.8
.4 .5 .1 .5 .25
P C R P R
P R C
P C R P R P C R P R
=
+
= = =
+
(continued)
Repay Repay
College
College
1.0 .5 .5
.2
.3
.05
.45
.25
.75
Total
Total

Chap 4-26
Random Variable
Random Variable
Outcomes of an experiment expressed numerically
e.g.: Toss a die twice; count the number of times
the number 4 appears (0, 1 or 2 times)

Chap 4-27
Discrete Random Variable
Discrete random variable
Obtained by counting (1, 2, 3, etc.)
Usually a finite number of different values
e.g.: Toss a coin five times; count the number of
tails (0, 1, 2, 3, 4, or 5 times)

Chap 4-28
Probability Distribution
Values Probability
0 1/4 = .25
1 2/4 = .50
2 1/4 = .25
Discrete Probability
Distribution Example
T
T
T T
Event: Toss two coins Count the number of tails

Chap 4-29
Discrete Probability Distribution
List of all possible [X
j
, p(X
j
) ] pairs
X
j
= value of random variable
P(X
j
) = probability associated with value
Mutually exclusive (nothing in common)
Collectively exhaustive (nothing left out)
( ) ( )
0 1 1
j j
P X P X s s =

Chap 4-30
Summary Measures
Expected value (the mean)
Weighted average of the probability distribution

e.g.: Toss 2 coins, count the number of tails,
compute expected value
( )
( )
j j
j
E X X P X = =
( )
( ) ( ) ( ) ( ) ( ) ( )
0 2.5 1 .5 2 .25 1
j j
j
X P X =
= + + =

Chap 4-31
Summary Measures
Variance
Weight average squared deviation about the mean

e.g. Toss two coins, count number of tails,
compute variance
(continued)
( )
( ) ( )
2
2
2
j j
E X X P X o
(
= =

( ) ( )
( ) ( ) ( ) ( ) ( ) ( )
2
2
2 2 2
0 1 .25 1 1 .5 2 1 .25 .5
j j
X P X o =
= + + =

Chap 4-32
Covariance and its Application
( ) ( ) ( )
( )
1
th
th
th
: discrete random variable
: outcome of
: discrete random variable
: outcome of
: probability of occurrence of the
outcome of an
N
XY i i i i
i
i
i
i i
X E X Y E Y P X Y
X
X i X
Y
Y i Y
P X Y i
X
o
=
= ( (

th
d the outcome of Y i

Chap 4-33
Computing the Mean for
Investment Returns
Return per $1,000 for two types of investments
P(X
i
Y
i
) Economic condition Dow Jones fund X Growth Stock Y
.2 Recession -$100 -$200
.5 Stable Economy + 100 + 50
.3 Expanding Economy + 250 + 350

Investment
( ) ( )( ) ( )( ) ( )( )
100 .2 100 .5 250 .3 $105
X
E X = = + + =
( ) ( )( ) ( )( ) ( )( )
200 .2 50 .5 350 .3 $90
Y
E Y = = + + =

Chap 4-34
Computing the Variance for
Investment Returns
P(X
i
Y
i
.2 Recession -$100 -$200

Investment
( ) ( ) ( ) ( ) ( ) ( )
2 2 2
2
100 105 .2 100 105 .5 250 105 .3
14, 725 121.35
X
X
o
o
= + +
= =
( ) ( ) ( ) ( ) ( ) ( )
2 2 2
2
200 90 .2 50 90 .5 350 90 .3
37, 900 194.68
Y
Y
o
o
= + +
= =

Chap 4-35
Computing the Covariance for
Investment Returns
P(X
i
Y
i
.2 Recession -$100 -$200

Investment
The Covariance of 23,000 indicates that the two investments are
positively related and will vary together in the same direction.
( )( )( ) ( )( )( )
( )( )( )
100 105 200 90 .2 100 105 50 90 .5
250 105 350 90 .3 23, 300
XY
o = +
+ =

Chap 4-36
Important Discrete
Discrete Probability
Distributions
Binomial Hypergeometric Poisson

Chap 4-37
Binomial Probability Distribution
n identical trials
e.g.: 15 tosses of a coin; ten light bulbs taken
from a warehouse
Two mutually exclusive outcomes on each
trials
e.g.: Head or tail in each toss of a coin; defective
or not defective light bulb
Trials are independent
The outcome of one trial does not affect the
outcome of the other

Chap 4-38
Binomial Probability Distribution
Constant probability for each trial
e.g.: Probability of getting a tail is the same each
time we toss the coin
Two sampling methods
Infinite population without replacement
Finite population with replacement
(continued)

Chap 4-39
Binomial Probability
Distribution Function
Tails in 2 Tosses of Coin
X P(X)
0 1/4 = .25
1 2/4 = .50
2 1/4 = .25
( )
( )
( )
( )
( )
!
1
! !
: probability of successes given and
: number of "successes" in sample 0,1, ,
: the probability of each "success"
: sample size
n X
X
n
P X p p
X n X
P X X n p
X X n
p
n
=

Chap 4-40
Binomial Distribution
Characteristics
Mean

E.g.
Variance and
Standard Deviation

E.g.

( )
E X np = =
( )
5 .1 .5 np = = =
n = 5 p = 0.1
0
.2
.4
.6
0 1 2 3 4 5
X
P(X)
( ) ( )( )
1 5 .1 1 .1 .6708 np p o = = =
( )
( )
2
1
1
np p
np p
o
o
=
=

Chap 4-41
Binomial Distribution in PHStat
PHStat | probability & prob. Distributions |
binomial
Example in excel spreadsheet


Chap 4-42
Poisson Distribution
Poisson Process:
Discrete events in an interval
The probability of One Success
in an interval is stable
The probability of More than
One Success in this interval is 0
The probability of success is
independent from interval to
interval
e.g.: number of customers arriving in 15 minutes
e.g.: number of defects per case of light bulbs
P X x
x
x
( |
!
=

e
-

Chap 4-43
Poisson Probability
Distribution Function
e.g.: Find the probability of 4
customers arriving in 3 minutes
when the mean is 3.6.
( )
3.6 4
3.6
.1912
4!
e
P X

= =
( )
( )
!
: probability of "successes" given
: number of "successes" per unit
: expected (average) number of "successes"
: 2.71828 (base of natural logs)
X
e
P X
X
P X X
X
e
=

Chap 4-44
Poisson Distribution in PHStat
Poisson


Chap 4-45
Poisson Distribution
Characteristics
Mean

Standard Deviation
and Variance

( )
( )
1

N
i i
i
E X
X P X

=
= =
=
= 0.5
= 6
0
.2
.4
.6
0 1 2 3 4 5
X
P(X)
0
.2
.4
.6
0 2 4 6 8 10
X
P(X)
2
o o = =

Chap 4-46
Hypergeometric Distribution
n trials in a sample taken from a finite
population of size N
Sample taken without replacement
Trials are dependent
Concerned with finding the probability of X
successes in the sample where there are A
successes in the population

Chap 4-47
Function
E.g. 3 Light bulbs were
selected from 10. Of the 10
there were 4 defective. What
is the probability that 2 of the
3 selected are defective?
( )
4 6
2 1
2 .30
10
3
P
| || |
| |
\ .\ .
= =
| |
|
\ .
( )
( )
: probability that successes given , , and
: sample size
: population size
: number of "successes" in population
: number of "successes" in sample
0,1, 2,
A N A
X n X
P X
N
n
P X X n N A
n
N
A
X
X
| || |
| |
\ .\ .
=
| |
|
\ .
=
( )
, n

Chap 4-48
Characteristics
Mean

Variance and Standard Deviation

( )
A
E X n
N
= =
( )
( )
2
2
2
1
1
nA N A
N n
N N
nA N A
N n
N N
o
o
Finite
Population
Correction
Factor

Chap 4-49
Hypergeometric Distribution in
PHStat
Hypergeometric

Chap 4-50
Chapter Summary
Discussed basic probability concepts
Sample spaces and events, simple
probability, and joint probability
Defined conditional probability
Statistical independence, marginal probability
Discussed Bayess theorem

Chap 4-51
Chapter Summary
Addressed the probability of a discrete
random variable
Defined covariance and discussed its
application in finance
Discussed binomial distribution
Addressed Poisson distribution
Discussed hypergeometric distribution

(continued)

Chap04 Probability BHBP Statistics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chap04 Probability BHBP Statistics

Uploaded by

Copyright:

Available Formats

2002 Prentice-Hall, Inc.

2002 Prentice-Hall, Inc.

2002 Prentice-Hall, Inc.

2002 Prentice-Hall, Inc.

You might also like