Expectations of Discrete Random Variables: Scott She Eld
Expectations of Discrete Random Variables: Scott She Eld
Expectations of Discrete Random Variables: Scott She Eld
440: Lecture 9
Expectations of discrete random variables
Scott Sheffield
MIT
18.440 Lecture 9
1
Outline
Defining expectation
Motivation
18.440 Lecture 9
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Outline
Defining expectation
Motivation
18.440 Lecture 9
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Expectation of a discrete random variable
E [X ] = xp(x).
x:p(x)>0
I
� Suppose that a random variable X satisfies P{X = 1} = .5,
I
� What is E [X ]?
I
� Answer: .5 × 1 + .25 × 2 + .25 × 3 = 1.75.
I
� Suppose P{X = 1} = p and P{X = 0} = 1 − p. Then what
is E [X ]?
I
� Answer: p.
I
� Roll a standard six-sided die. What is the expectation of
18.440 Lecture 9
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Expectation when state space is countable
E [X ]?
18.440 Lecture 9
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A technical point
�
I If the state
n space S is countable, is it possible that the sum
E [X ] = s∈S P({s})X (s) somehow depends on the order in
which s ∈ S are enumerated?
�
I In
n principle, yes... We only say expectation is defined when
s∈S P({x})|X (s)| < ∞, in which case it turns out that the
sum does not depend on the order.
18.440 Lecture 9
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Outline
Defining expectation
Motivation
18.440 Lecture 9
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Outline
Defining expectation
Motivation
18.440 Lecture 9
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Expectation of a function of a random variable
�
I If X is a random variable and g is a function from the real
numbers to the real numbers then g (X ) is also a random
variable.
�
I How can we compute E [g (X )]?
�
I Answer:
X
E [g (X )] = g (x)p(x).
x:p(x)>0
�
I Suppose that constants a, b, µ are given and that E [X ] = µ.
�
I What is E [X + b]?
�
I How about E [aX ]?
�
I Generally, E [aX + b] = aE [X ] + b = aµ + b.
18.440 Lecture 9
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More examples
�
I Let X be the number that comes up when you roll a standard
�
I Let Xj be 1 if the jth coin toss isnheads and 0 otherwise.
�
I Alternatively, use symmetry. Expected number of heads
should be same as expected number of tails.
�
I This implies E [X ] = E [n − X ]. Applying
18.440 Lecture 9
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Additivity of expectation
�
I If X and Y are distinct random variables, then can one say
that E [X + Y ] = E [X ] + E [Y ]?
�
I Yes. In fact, for real constants a and b, we have
E [aX + bY ] = aE [X ] + bE [Y ].
�
I This is called the linearity of expectation.
�
I Another way to state this fact: given sample space S and
�
I Can extend to more variables
18.440 Lecture 9
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More examples
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18.440 Lecture 9
Outline
Defining expectation
Motivation
18.440 Lecture 9
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Outline
Defining expectation
Motivation
18.440 Lecture 9
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Why should we care about expectation?
�
I Laws of large numbers: choose lots of independent random
variables same probability distribution as X — their average
tends to be close to E [X ].
�
I Example: roll N = 106 dice, let Y be the sum of the numbers
that come up. Then Y /N is probably close to 3.5.
�
I Economic theory of decision making: Under “rationality”
assumptions, each of us has utility function and tries to
optimize its expectation.
�
I Financial contract pricing: under “no arbitrage/interest”
assumption, price of derivative equals its expected value in
so-called risk neutral probability.
18.440 Lecture 9
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Expected utility when outcome only depends on wealth
�
I Contract one: I’ll toss 10 coins, and if they all come up heads
(probability about one in a thousand), I’ll give you 20 billion
dollars.
�
I Contract two: I’ll just give you ten million dollars.
�
I What are expectations of the two contracts? Which would
you prefer?
�
I Can you find a function u(x) such that given two random
wealth variables W1 and W2 , you prefer W1 whenever
E [u(W1 )] < E [u(W2 )]?
�
I Let’s assume u(0) = 0 and u(1) = 1. Then u(x) = y means
18.440 Lecture 9
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