Question

. Let X and Y be random variables of possible percent returns (0%, 10%,

15%, and 20%) for stock A and, with the joint probability distribution given
in the Table below:
Joint Probability Distribution for Random Variables X and Y
Y Return
X Return 0 5 10 15
0 0.0625 0.0625 0.0625 0.0625
5 0.0625 0.0625 0.0625 0.0625
10 0.0625 0.0625 0.0625 0.0625
15 0.0625 0.0625 0.0625 0.0625
(a) Find the marginal probabilities.
(b) Determine if X and Y are independent.
(c) Find the means and variances of both X and Y.

Answer 1

(a) The marginal distribution of X is

Pr(X = x) = ∑ Pr(X = x, Y = y)

… = 0.0625 + 0.0625 + 0.0625 + 0.0625

… = 0.25

That is, the first equality follows from the law of total probability, with the sum taken over y from {0, 5, 10, 15}. Each probability Pr(X = x, Y = y) is given in the table to be 0.0625.

Similarly, the marginal distribution of Y is

Pr(Y = y) = 0.25

(b) Yes, they're independent because

Pr(X = x, Y = y) = 0.0625,

and

Pr(X = x) Pr(Y = y) = 0.25 • 0.25 = 0.0625.

(c) The mean of X is

E[X] = ∑ x Pr(X = x)

… = 0.25 ∑ x

… = 0.25 (0 + 5 + 10 + 15)

… = 7.5

and you would find the same mean for Y,

E[Y] = 7.5

The variance of X is

V[X] = E[X^2] - E[X]^2

… = (∑ x^2 Pr(X = x)) - 7.5^2

… = 0.25 (∑ x^2) - 56.25

… = 0.25 (0^2 + 5^2 + 10^2 + 15^2) - 56.25

… = 31.25

and similarly,

V[Y] = 31.25

(each sum is taken with x and y from {0, 5, 10, 15})