JOINT PROBABILITY DISTRIBUTION

Dr. Sujay K Mukhoti

Associate Professor of Statistics

August 11, 2021

 IPS

SM-Stat

Two Random
Variables

Correlation 1 Two Random Variables

iid Random
Variables

2 Correlation

3 iid Random Variables

 Readings

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Two Random
Variables

Correlation
Text Book Chapters:
iid Random
Exercise:
Variables
 Portfolios and Random Variables

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Two Random
Portfolio: a bouquet of assets
Variables

Correlation
Examples:

iid Random
1 Portfolio of products: TATA group
Variables
2 Portfolio of experts: KAISEN Teams
3 Portfolio of specialization: HR Manager handling Risk
analytics, BD and MIS teams
4 Portfolio of assets: land, cash, gold, investments
 Two random variables I

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Two Random Stock price on a day: Microsoft & IBM – $100

Variables

Correlation
X: change in IBM stock; Y: change in Microsoft stock
x P(X = x) y P(Y = y )
iid Random
Variables
5 0.11 4 0.18
0 0.8 0 0.67
-5 0.09 -4 0.15
A day trader has $200. Where to invest?
 Bivariate Probability Table I

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Two Random IBM

Microsoft
Variables -5 0 5
Correlation
-4 0.07 0.11 0.00
0 0.02 0.62 0.03
iid Random 4 0.03 0.07 0.05
Variables

Joint probability and independence PXY = PX PY

Conditional probability & Expectation:

PXY cell prob.
P[X = x | Y = y ] = Py = marginal prob.
 Bivariate Probability Table II

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SM-Stat Conditional expectation: Morning news: IBM declares

Two Random
profit in the last quarter and the market sees gain in IBM
Variables
shares. What do you expect from Microsoft given this
Correlation
information?
iid Random P
Variables E [X | Y = y ] = x xP[X = x | Y = y ]

Independence & Multiplication Rule for Expectation:

E [XY ] = E [X ]E [Y ]

Joint pmf: cell probability generating function

f (x, y ) = cx 2 y , x = 0, 1, 2; y = 2, 4, 6
 Problems: Joint probability I

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The following table shows the covariance between Sales
SM-Stat forecast (X) for summers and cost requirement from their
advertisement agency (Y) in thousand–dollars around the same
Two Random
Variables
time for Showcase Cinemas

Correlation Advt. Cost (Y)

Sales (X)
75 100 200
iid Random
Variables
70 0.13 0.12 0.03
100 0.16 0.20 0.03
120 0.03 0.17 0.13
1 Are Sales and Advt. costs independent?

2 What is the probability that the cinema will break even?

3 What is the chance of getting maximum sales, if they have

invested the minimum?
 Problems: Joint probability II

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Two Random 4 What is the probability making profit if they have invested
Variables
only the minimum amount (i.e. $75000)?
Correlation
5 The cinema wants to decide what amount of investment in
iid Random
Variables advertisement derives maximum gain from expected sales
as a percentage of investment. Help them with your
knowledge in statistics.
 Covariance:Co-movement of two RVs

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SM-Stat
Cov (X , Y ) = E [(X − µx )(Y − µy )] = E [XY ] − µx µy
Two Random
Variables

Correlation
Cov (X , Y ) measures degree of linear co-movement
iid Random
Variables
between X and Y

Cov (X , X ) = σx2

Cov (X , Y ) is unbounded

Cov (a + bX , c + dY ) = bdCov (X , Y )

Covariance is unit dependent measurement

 Correlation: Degree of co-linearity

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Two Random Cov (X , Y ) σXY

ρ = Cor (X , Y ) = =
Variables σx σy σx σy
Correlation

iid Random
Variables
−1 < ρ < 1

ρ = −1 ⇒ perfect opposite movement

ρ = 1 ⇒ perfect similar movement

ρ is unit free
 Problem: Correlation I

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Yellow sub-marine is a popular sandwich van in the Hatton
Gardens, London. The owner from Southamptonshire, Von
Two Random Bjorgman, sells his famous south sausage baguette with a spicy
Variables
drink of his recipe. The following table shows the sales per
Correlation customer for Bjorgman:
iid Random Sandwich (Y)
Variables
Drinks (X) 1 2
0 0.15 0.05
1 0.35 0.15
2 0.13 0.17

1 What is the expected number of sandwiches sold per

customer? Variance?
 Problem: Correlation II

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SM-Stat 2 What is the expected number of drinks sold per customer?

Two Random Variance?
Variables
3 If the sandwiches are sold at £4 and drinks cost £2, then
Correlation

what is the expected revenue? What is the variance?

iid Random
Variables Covariance between sandwich and drinks revenue? What
are the units of measurements of these quantities?

4 Are they related? Discuss the nature of relationship

between sandwich and drinks based on correlation
coefficient.
 Problem: Correlation III

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Two Random
Variables

Correlation
5 What is the probability distribution of no. of drinks per
iid Random
Variables
sandwich? Expected number of drinks per sandwich?
 Sums of Random Variables

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Two Random
Variables E [X + Y ] = E [X ] + E [Y ]
Correlation
V (X + Y ) = V (X ) + V (Y ) + 2Cov (X , Y )
iid Random
Variables
= σx2 + σy2 + 2ρσx σy

E [aX + bY ] = aE [X ] + bE [Y ]

V (aX + bY ) = a2 σx2 + b 2 σy2 + 2abρσx σy

 Portfolio Sharpe Ratio

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$C : total investment capital

Two Random
Variables
ω: proportion of total investment in X
Correlation
1 − ω: investment proportion in Y
iid Random
Variables Asset Risk: σx , σy ; Co-movement risk: σxy = ρσx σy

Portfolio return: rP = ωrX + (1 − ω)rY

Portfolio risk: σP2 = ω 2 σx2 + (1 − ω)2 σy2 + 2ρω(1 − ω)σx σy

ωµx +(1−ω)µy −rf
Portfolio Sharpe Ratio: SP = σP
 iid Random Variable

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identical random variables X and Y : same mean
Two Random
Variables (µX = µY ), variances (σX = σY )
Correlation independent random variables: ρ = 0 (but not the
iid Random
converse).
Variables

iid X and Y : f (x, y ) = f (x)f (y )

If returns from consecutive days are iid for IBM, what is

more beneficial: invest $100 for two days or invest $200
for one day?