2021 FIN2210 Problem Set 5

Probability for Finance

1. If the random variable X has pdf

𝑥−1
f(x) = { 2 , 𝑖𝑓 1 < 𝑥 < 3
0, 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒

Find a monotone function g(x) such that the random variable Y = g(X) has a
uniform (0,1) distribution.

2. Let X have the pdf

𝑥2
4 2 −𝛽 2
f(𝑥) = 𝑥 𝑒 ,0 < 𝑥 < ∞, 𝛽 > 0
𝛽 3 √𝜋

Find E(X) and Var(X).

𝑥2
1 −
3. Let X have the standard normal pdf 𝑓𝑋 (𝑥) = 𝑒 2 for −∞ < x < ∞.
√2𝜋

(a) Find E(X 2 ) directly, and then by using the pdf of Y = X 2 and calculating
E(Y). Compare the answers of both the approaches.
(b) Find the pdf of Y = |X|, and find its mean and variance. (The distribution of Y
is sometimes called a folded normal.)

4. a) Let X be a continuous, nonnegative random variable [f(x) = 0 for x < 0].

∞
Show that E(X) = ∫0 [1 − 𝐹𝑋 (𝑥)]𝑑𝑥, where 𝐹𝑋 (x) is the CDF of X.

b) Let X be a discrete random variable whose range is nonnegative integers.

Show that E(X) = ∑∞
𝑘=0[1 − 𝐹𝑋 (𝑘)], where 𝐹𝑋 (k) = P(X ≤ k) Compare this

with part (a).

1
5. A median of a distribution is a value m such that P(X ≤ m) ≥ 2 and P(X ≥
 1 𝑚 ∞ 1
m) ≥ 2. (If X is continuous, m satisfies ∫−∞ 𝑓(𝑥)𝑑𝑥 = ∫𝑚 𝑓(𝑥)𝑑𝑥 = 2 ) In

other words, the median is a cutoff point that divides the probability distribution
into two equal halves. Find the median of the following distribution called Cauchy
1
distribution: f(𝑥) = 𝜋(1+𝑥 2 ) , −∞ < 𝑥 < ∞.

6. Let f(𝑥) be a pdf, and let a be a number such that, for all ε > 0, f(a − ε) = f(a +
ε). Such a pdf is said to be symmetric about the point a.
(a) Give three examples of symmetric pdfs.
(b) Show that if X ~ f(𝑥), symmetric, then the median of X is the number a.
(c) Show that if X ~ f(𝑥), symmetric, and E(X) exists, then E(X) = a.

𝛽𝛼𝛽
7. The Pareto distribution, with parameters α and β, has pdf f(𝑥) = 𝑥 𝛽+1 ，α <

𝑥 < ∞, β > 0, α > 0.

(a) Verify that f(𝑥) is a pdf.
(b) Derive the mean and variance of this distribution.
(c) Prove that the variance does not exist if β ≤ 2.