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Examples: Random Variables

The document discusses random variables and provides examples of calculating mean and standard deviation of portfolios containing stocks from different industries, customers' purchases at a retailer, the correlation between random variables, and the Sharpe ratio for evaluating investment portfolios.

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52 views6 pages

Examples: Random Variables

The document discusses random variables and provides examples of calculating mean and standard deviation of portfolios containing stocks from different industries, customers' purchases at a retailer, the correlation between random variables, and the Sharpe ratio for evaluating investment portfolios.

Uploaded by

srivastavavishist
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Random Variables

Examples
A portfolio includes stocks in three industries: financial, energy, and
consumer goods (in equal proportions). Assume that these three
sectors are independent of each other and that the expected annual
return (in dollars) and standard deviations are as follows: financial:
1,000 and 700; energy 1,200 and 1,100; and consumer goods 600
and 300. What are the mean and standard deviation of annual
dollar-value return on this portfolio?

Prof. Pritam Ranjan IPS (July 12, 2017) 26/31


Random Variables

Examples
(Eg. 10.*) Ten customers are waiting in line to pay for purchases at
a busy retailer during the holidays. Let X1 , X2 , ..., X10 denote the
amounts bought by these customers, and model them as iid random
variables with mean $150 and standard deviation $50.
What are the mean and standard deviation of the total
amount purchased by these 10 customers?
Why is the standard deviation of the sum of the 10 purchases
so much less than 10 times the standard deviation of each?

Prof. Pritam Ranjan IPS (July 12, 2017) 27/31


Random Variables

Examples
If Var (X + Y ) = 8 and Var (X ) = Var (Y ) = 5, then what is the
correlation between X and Y ?

What’s the covariance between a random variable X and a


constant?

Prof. Pritam Ranjan IPS (July 12, 2017) 28/31


Random Variables

Application
Consider comparing stock price of Reliance in BSE with that of
CITI in NYSE.

Directly comparing the monthly prices would not be right as they


are in two different risk groups (risk is measured by standard
deviation of it). Also the units (here INR and $) are different.

Standardize - the ratio becomes independent of $ unit and risk

William Sharpe defined the following measure


� �
X − µf
S =E
σ
where µf is risk-free rate of return, σ quantifies the risk.

Prof. Pritam Ranjan IPS (July 12, 2017) 29/31


Random Variables

Sharpe Ratio - example


Suppose that you currently have $250,000 invested in a portfolio
with an expected return of 12% and a volatility of 10%. The
efficient (tangent) portfolio has an expected return of 17% and a
volatility of 12%. The risk-free rate of interest is 5%. What is the
Sharpe ratio of your portfolio?

Prof. Pritam Ranjan IPS (July 12, 2017) 30/31


Random Variables

Homework

Practice questions:
Chapters 9 and 10

Next topic: A few popular (discrete) Random Variables

Finish unsolved examples from today’s lecture

Prof. Pritam Ranjan IPS (July 12, 2017) 31/31

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