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For any real number y, define y+by

y+=y,ify≥00,ify<0

Let cbe a constant.

(a) Show that

E(Z-c)+=12πe-c2/2-c(1-Φ(c))

when Zis a standard normal random variable.

(b) Find E(X-c)+when Xis normal with mean μand variance σ2.

Short Answer

Expert verified

a. Using the concept of a random variable's expectation it is proved.

b. The value of E(X-c)+is1σ×12πe-c-μσ22-c-μσ1-Φc-μσ.

Step by step solution

01

Random variable

Observe that the random variable (Z-c)+is, in fact, a random variable.

(Z-c)+(Ӭ)=Z(Ӭ)-c,Z(Ӭ)≥c0,Z(Ӭ)<c

forӬ∈Ӭ, where probability space is(Ӭ,F,P).

02

Showing of standard normal random variable (part a)

a.

Intended consequence is,

E(Z-c)+=∫Ω(Z-c)+(Ӭ)dP(Ӭ)

=∫mtight" style="margin-right:0.07153em;">Z(Ӭ)≥c(Z(Ӭ)-c)dP(Ӭ)

Density function,

φ(z)=12πe-z22

So integral is,

∫Z(Ӭ)≥c(Z(Ӭ)-c)dP(Ӭ)=∫z≥c(z-c)φ(z)dz

=∫c∞³úφ(z)dz-c∫c∞φ(z)dz

First integral,

u=z22⇒du=zdz

Substitute values we get,

∫c∞³úφ(z)dz=12π∫c∞ze-z22dz

=12π∫c22∞e-udu

=12Ï€e-c22

Second integral,

E(Z-c)+=12πe-c22-c(1-Φ(c))

03

Calculation of E(X-c)+ (part b)

b.

For,

X~Nμ,σ2.

Hence Z=X-μσ~N(0,1).

So, X=σ´Ü+μ.

(X-c)+=(σ´Ü+μ-c)+

=1σZ-c-μσ+

since σ>0.

Using part (a) we get,

E(X-c)+=1σEZ-c-μσ+

=1σ×12πe-c-μσ22-c-μσ1-Φc-μσ

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