Exercise Session 9, 27 November 2018

Mathematics for Economics and Finance

Prof: Norman Schürhoff
TAs: Jakub Hajda, Jimmy Lerch

Exercise 1
You have two random variables, X and Y . Consider three statements:
A = ‘The expectation of the product of X and Y is equal to zero. That is, E[XY ] = 0.’
B = ‘The correlation between X and Y is zero.’
C = ‘X and Y are independent.’
For the following statements, state whether they are true or false and explain why:

(a) ¬B =⇒ ¬A
(b) A =⇒ B
(c) C =⇒ B
(d) C =⇒ (A ∩ B).

Exercise 2

For random variables X, Y ∼ N 0, σ 2 determine


(a) E X X 2
(b) E (X |XY )


(c) E X 2 + Y 2 |X + Y .

Exercise 3
Consider the following conditional density for Y given X = x is

2y + 4x
f Y |X ( y| x) = .
1 + 4x
The marginal density of x is
1 + 4x
fX (x) = ,
3
for 0 < x < 1 and 0 < y < 1. Find
(a) the joint density fXY (x, y),

(b) the marginal density of Y , fY (y), and

(c) the conditional density for X given Y = y, f X|y ( x| y).

1
Exercise 4
2
Show that if (X, Y ) ∼ N2 (µX , µY , σX , σY2 , ρ) then the following is true:
2
(a) The marginal distribution of X is N (µX , σX ) and the marginal distribution of Y is N (µY , σY2 ).
(b) The conditional distribution of Y given X = x is N (µY + ρ( σσX
Y
)(x − µX ), σY2 (1 − ρ2 )).

Exercise 5

Suppose a sample X1 , X2 , . . . , Xn is drawn randomly from normal distribution N θ, σ 2 .

(a) Show that X and Xi − X are uncorrelated for i = 1, 2, . . . , n.

(b) Show that Cov X, S 2 = 0.
σ2
(c) Show that θb2 = X 2 − n is unbiased estimator of θ2 .

Exercise 6
Consider a model
y = Xβ + ε, (1)
0 0
where y = (y1 , ..., yN ) and X = (X1 , ..., XN ) for i = 1, ..., N . The matrix X is known and is of size N × K.
Assume the error term ε = (ε1 , ..., εN )0 follows a Normal distribution with E(ε) = 0, Cov(X, ε) = 0, and
V ar(ε) = σ 2 I.

(a) Compute the OLS estimator of β, β̂. How would you compute it if X was unknown?

(b) Find the sampling error of β̂.

(c) Show that β̂ is unbiased.

(d) Find the variance of β̂ for given X in the case of homoscedastic errors.
(e) Suppose now that V ar(ε) = σ 2 Ω, where Ω is an N × N matrix that may have non-equal diagonal elements
(heteroskedasticity), non-zero off-diagonal elements (serial correlation), or both.
[1.] Which mathematical result allows you to find a non-singular matrix P such that P 0 P = Ω−1 ? Now
consider the transformed model
y ∗ = X ∗ β + ε∗ , (2)
where y ∗ = P y, X ∗ = P X, and ε∗ = P ε. Assume P exists, what is the best linear unbiased estimator
(BLUE) for the transformed model (2)?
[2.] Determine the best linear unbiased estimator of β in the original model (1) in terms of X, y and Ω.
What is the variance of the BLUE? Compare it to V ar(βbOLS ). What do you conclude about βbOLS ?

(f) Show that the β̂ is BLUE (best linear unbiased estimator), i.e. prove the Gauss-Markov theorem.

Exercise 7
A random variable X ∼ Γ(α, β) has expected value α/β and variance α/β 2 . Find the method of moments
estimators of α and β.