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You are on page 1of 13

1-13

Random Variable

Random variable (): is an uncertain quantity/number.

Outcome (): is an observed value of a random variable.

Event (): is a single outcome or a set of outcomes.

Mutually exclusive events (): are events that cannot both happen at

the same time.

Exhaustive events (): are those that include all possible outcomes.

for a random variable.

2-13

A probability function, denoted p(x), specifies the probability that a random

variable is equal to a specific value. More formally, p(x) is the probability that

random variable X takes on the value x, or p(x) = P(X = x).

0 p(x) 1.

p(x) = 1, the sum of the probabilities for all possible outcomes, x, for a

random variable, X, equals 1.

3-13

(a) Probability density function

f(X)

-1

1

F(X)

0

-1

4-13

Conditional probability : P(A B)=

P(AB)

P(B)

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

P(B)

P(A)

A

P(AB)

5-13

The occurrence of A has no influence of on the occurrence of B

P(A|B)=P(A) or P(B|A)=P(B)

P(AB)=P(A)P(B)

P(A or B)=P(A)+P(B)-P(A)P(B)

Addition rule: P(A or B)=P(A)+P(B)-P(AB)

P(B)

P(A)

P(AB)

6-13

Bond A and Bond B have the same rating and the same probability of default. It

is also estimated that:

The probability that both Bond A and Bond B will default during the next

year is 5%; and

If Bond A defaults next year, there is a 50% probability that Bond B will

also default.

What is the probability that neither Bond A nor Bond B will default over the

next year?

A. 75%

B. 80%

P(AB)

5%

P

(AB)

5%;

P

(B

A)

C. 85%

P(A) P (A)

D. 95%

P( A B) 1 P ( A B ) 1 P (A) P (B ) P (AB)

=1 - (10%+10%-5%)=85%

7-13

Probability Matrix

Joint and Unconditional Probabilities

Interest Rates

Increase

Economy

8-13

No Increase

Good

14%

6%

20%

Normal

20%

30%

50%

Poor

6%

24%

30%

40%

60%

100%

Answer:

9-13

Bayes Formula

P(AB)=P(A|B)P(B) =P(B|A)P(A)

P( B | A)

P( A | B)

P( A)

P( B)

Example:

:

0.3

0.7

0.8

0.2

0.1

0.9

10-13

Bayes Formula

80%

30%

20%

10%

90%

70%

11-13

You are examining a pool of senior secured loans and observe that 10% of the loans are

delinquent () in their interest payments. The outstanding balance on 60% of the

delinquent loans exceeds the value of the collateral pledged to secure them and the

outstanding balance on 30% of the non-delinquent loans exceeds the value of the collateral

pledged to secure them. If you randomly select a loan from the pool and observe that its

collateral value is less than the outstanding balance, what is the probability that the loan is

delinquent?

A.

6%

B.

9%

C.

18%

D.

54%

12-13

FRM

13-13

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