Exercise Session 7, 13 November 2018

Mathematics for Economics and Finance

Prof: Norman Schürhoff
TAs: Jakub Hajda, Jimmy Lerch

Exercise 1
Compute the following expression using Leibniz’s Formula:
Z α
ln(1 + αβ)
F 0 (α) for F (α) = dβ.
0 β

Solution 1

α
ln(1 + α2 ) ln(1 + α2 ) ln(1 + αβ) ln(1 + α2 )
Z α
0 1 β
F (α) = + dβ = + =2 .
α 0 β 1 + αβ α α 0 α

Exercise 2
A laboratory is running blood tests in order to detect a disease. This test detects 95% of diseased and detects by
error the disease to 1% of healthy people. We know that 0.5% of the population has this disease. Compute the
probability that someone is indeed sick given that the test detected the disease.

Solution 2
Let the event A be ”the person is sick”. Let the event B be ”the test says the person is sick”. We want to compute
P(A | B) and have the following information:
95
P(B | A) =
100
1
P(B | Ac ) =
100
1
P(A) =
200
First of all, let us compute P(B):

P(B) = P(B | A)P(A) + P(B | Ac )P(Ac )

   
95 1 1 199
= × + ×
100 200 100 200
147
=
10000

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Using Bayes’s formula, we obtain:
P(B | A)P(A)
P(A | B) =
P(B)
95 1 10000
= × ×
100 200 147
95
=
294
= 0.323

Therefore, the person is sick only one third of the times the test says she is sick. We cannot rely on this test!

Exercise 3
There are exactly 64350 gold coins in a chest. One of them is drawn randomly and tossed 5 times. Each time the
outcome is ”heads”.

(a) What is the probability of this event ?

(b) Now it appears that one of the coins was counterfeit : it had ”heads” on both sides. What is the probability
that the coin that was drawn and tossed initially was actually the counterfeit ?
(c) Later on you learn that there were another 29 counterfeits among those in the chest, all of which had ”tails”
on both sides. Recalculate the probability that the coin tossed was the one with ”heads” on both sides.

Solution 3
(a) For each tossing the probability of the outcome “heads” is P (”heads”) = 12 . Outcomes of consecutive
tossings are independent events =⇒ probability of 5 consecutive outcomes “heads” is P (5 ”heads”) = 215 .
(b) One can apply Bayes’s Theorem:

P (counterf eit) · P (5 ”heads” | counterf eit)

P (counterf eit | 5 ”heads”) =
P (5 ”heads”)

1 1
P (counterf eit) = =
N 64350
P (5 ”heads” | counterf eit) = 1.(Obviously)

P (5 ”heads”) = P (counterf eit) · P (5 ”heads” | counterf eit) + P (normal) · P (5 ”heads” | normal) =

 
1 1 1
= ·1+ 1− · 5.
64350 64350 2
1
64350 ·1 1 1
Therefore, P = = 2011.9 ≈ 2012 .
1
64350 ·1+( 1− 1
64350 )· 215
(c) Bayes’s formula adjusted for part (c) is as follows:

1
0
64350 1
P = 1 29 30

1 = .
64350 ·1+ 64350 ·0+ 1− 64350 · 25
2011

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Exercise 4
Let A and B be two independent events.
1) Show that Ac and B c are independent.
2) Show that Ac and B are independent.
3) Compute P(A | B)

Solution 4
1)
P(Ac ∩ B c ) = 1 − P(A ∪ B)
= 1 − (P(A) + P(B) − P(A ∩ B))
= 1 − P(A) − P(B) − P(A)P(B)
= (1 − P(A))(1 − P(B))
= P(Ac )P(B c )
Therefore, Ac and B c are independent.
2)
P(Ac ∩ B) = P(B) − P(A ∩ B)
= P(B) − P(A)P((B)
= P(B)(1 − P(A))
= P(B)P(Ac )
Therefore, Ac and B are independent.
3) We know that A and B are independent, therefore we have
P(A ∩ B) P(A)P(B)
P(A | B) = = = P(A)
P(B) P(B)

Exercise 5
Let A1 , A2 , A3 be independent random events such that 0 < Pr(Ai ) < 1. Check if the following events are
independent:
(a) A1 ∩ Ac2 and A3 ,
(b) A1 ∩ A2 and A2 ∪ A3 .

Solution 5
(a) The sets are independent.
(b) The sets are not independent.

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Exercise 6
For events A, B, C, C1 , C2 such that 0 < P (C) < 1 which of the following statements are true?

(a) P (A) > P (B) =⇒ P (A ∩ C) > P (B ∩ C)

(b) P (A |C ) = P (A) , P (B |C ) = P (B) , P (A) > P (B) =⇒ P (A ∩ C) > P (B ∩ C)
(c) P (A |C ) ≥ P (B |C ) , P (A |C c ) ≥ P (B |C c ) =⇒ P (A) ≥ P (B)
(d) 0 < P (Ci ) < 1, ∪2i=1 Ci = Ω, P (A |Ci ) ≥ P (B |Ci ) =⇒ P (A) ≥ P (B)

Solution 6
(a) False. Counterexample: let C = Ac =⇒ P (A ∩ C) = P (A ∩ Ac ) = 0 > P (B ∩ Ac ) which cannot be true.
(b) True. Since A and B are independent from C =⇒ P (A ∩ C) = P (A) P (C) , P (B ∩ C) = P (B) P (C).
Thus from P (A) > P (B) follows P (A ∩ C) > P (B ∩ C).
(c) True. We have P (A |C ) P (C) ≥ P (B |C ) P (C) , P (A |C c ) P (C c ) ≥ P (B |C c ) P (C c ) =⇒

P (A) = P (A |C ) P (C) + P (A |C c ) P (C c ) ≥ P (B |C ) P (C) + P (B |C c ) P (C c ) = P (B) .

(d) False. Counterexample: Ω = {ω1 , ω2 , ω3 } , P (ωi ) = 1/3, A = {ω1 } , B = {ω2 , ω3 } , C1 = {ω1 , ω2 } , C 2 =

{ω1 , ω3 } .

Exercise 7
Given a complete probability space (Ω, F, P). Prove that the conditional probability defined by

P (A ∩ B)
P ( A| B) = ,
P (B)
with A, B ∈ F is a probability measure.

Solution 7
From the lecture notes we know that a probability measure is defined by the three axioms of Kolmogorov, i.e
(a) P (∅) = 0,
(b) P (Ω) = 1,
S∞ P∞
(c) P ( i=1 Ai ) = i=1 P (Ai ) for disjoint sets A1 , A2 , . . . ∈ F.
Thus, we have just to check whether the conditional probability measure satisfies all three conditions. In order
to show that all conditions are in fact true we fix the event B and just write Q (A) := P ( A| B) as short-hand
notation. Assume that all axioms are fulfilled for unconditional probabilities, like P (A) for any set A ∈ F.
Ad 1.
P (∅ ∩ B) P (∅)
Q (∅) = = = 0,
P (B) P (B)
Ad 2.
P (Ω ∩ B) P (B)
Q (Ω) = = = 1,
P (B) P (B)

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Ad 3.
∞ ∞
! S∞ S∞ P∞
[ P (( i=1 Ai ) ∩ B) P ( i=1 (B ∩ Ai )) i=1 P (B ∩ Ai )
X
Q Ai = = = = Q (Ai ) ,
i=1
P (B) P (B) P (B) i=1

because the sets (B ∩ Ai ) are disjoint for all i = 1, . . . , ∞.

This completes our proof.

Exercise 8
(Exercise Session 2013) Let us assume the random variable Xt to be distributed as follows ∀t = 1...T :
 1
2 if x = 1,
P[Xt = x] = 1
2 if x = −1.
Then we rewrite the sum of those independent random variables as:
t
X
Wt = Xi .
i=1

Compute the expectation and variance of the random variable WT .

Solution 8

E[Xt ] = 21 × 1 + 21 × (−1) = 0
V[Xt ] = E[Xt2 ] − E[Xt ]2
E[Xt2 ] = 12 × 12 + 12 × (−1)2 = 1, ⇒
V[Xt ] = 1 − 02 = 1
With this, we can compute the expectation and the variance of Wt .
Pt
E[Wt ] = E[ i=1 Xi ]
Pt
= i=1 E[Xi ] = 0
| {z }
Pt =0
V[Wt ] = V[ i=1 Xi ]
Pt
= i=1 V[Xi ] = t
| {z }
=1

Exercise 9
Suppose that the random variable X the following pdf
( √
√ cx if x ∈ [0, 2 3],
fX (x) = x2 +4 √
0 if x∈/ [0, 2 3].

(a) Find the constant c.

(b) Find the cdf of X.
(c) Find the pdf of Y = X 2 + 4.

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Solution 9
(a) Recall the definition of the pdf:
R +∞
−∞
fX (x)dx = 1
√
R 2√3 √ 2 3
We get: √ cu du = c u2 + 4 = 1 ⇒ 2c = 1 ⇒ c = 1
0 u2 +4 0 2


 0, x<0
√
R min(x,2√3) 1 u √  √ √ 

1 min(x,2 3)
(b) FX (x) = 0 2
2 u2 +4 du = 2 u + 4 0
√ = 21 x2 + 4 − 1, x ∈ 0, 2 3 ;
√



1, x>2 3

     

1 1 1 1
2
(c) FY (y) = P (Y ≤ y) = P X + 4 ≤ y = P −(y − 4) 2 ≤ X ≤ (y − 4) 2 = FX (y − 4) 2 −FX −(y − 4) 2
   
1 1 1 1
Since −(y − 4) 2 has has to be negative, FX −(y − 4) 2 = 0 and FX (y − 4) 2 = 12 y 2 − 1
1 1
⇒ FY (y) = 21 y 2 − 1, (pdf) fY (y) = 14 y − 2 .

Exercise 10
(optional) Suppose that the random variable X has an exponential distribution with pdf

exp(−x) if x > 0,
fX (x) =
0 if x 6 0.

Find the pdf for

1
(a) Y = X,

(b) Y = ln X.

Solution 10
The cdf fro the exponential distribution is
Z x Z x
−u x
FX (x) = e du = e−u du = −e−u 0
= 1 − e−x .
−∞ 0

1
1 − y1
(a) Y = 1/X, y > 0 (cdf) FY (y) = e− y , (pdf) fY (y) = y2 e .
y y
(b) Y = ln X, y ∈ R. (cdf) FY (y) = 1 − e−e , (pdf) fY (y) = ey−e