Discrete Probability

Distributions
 Discrete Continuous
Probability Probability
Feature Distribution Distribution
Countable (finite
or countably Uncountable (any
Random Variable infinite) value in an interval)

Probability Function
Probability Mass Probability Density
Function (PMF) Function (PDF)
Key
Probability of a Single Point Non-zero Zero Differences
Calculation Summation (∑) Integration (∫)
Curve (the area
under which is
Graphical Representation Bar Chart probability)
Number of cars Height of students,
Examples sold, dice rolls temperature
Introductory Case: Available Staff
for Probable Customers (1)

• Anne Jones is a manager of a local

Starbucks. Due to a weak economy and
higher gas and food prices, Starbucks
announced plans in 2008 to close 500 U.S.
locations.
• While Anne’s store will remain open, she is
concerned that nearby closings might affect
her business.
• A typical Starbucks customer visits the chain
between 15 and 18 times a month.
• Based on all this, Anne believes that
customers will average 18 visits to her store
over a 30-day month.
Introductory Case: Available Staff for
Probable Customers (2)
• Anne needs to decide staffing needs.
• Too many employees would be costly to the store.
• Not enough employees could result in losing customers who choose not to wait.
• With an understanding of the probability distribution of customer arrivals, Anne will be
able to:
1. Calculate the expected number of visits from a typical Starbucks customer in a
given time period.
2. Calculate the probability that a typical customer visits the store a specific
number of times in a given time period.
 Random Variables and Discrete Probability
Distributions (1)

• Random variable
• A function that assigns numerical values to the outcomes of an
experiment.
• Denoted by uppercase letters (e.g., X ).

• Values of the random variable are denoted by corresponding lowercase

letters: x1, x2, x3, . . .
 Random Variables and Discrete
Probability Distributions…

• Random variables may be classified as:

• Discrete
• The random variable assumes a countable number of distinct
values.
• Continuous
• The random variable is characterized by uncountable values in
an interval.
LO 5.1
 Random Variables and Discrete
Probability Distributions…
• Consider an experiment in which two shirts are selected from
the production line and each is either defective (D) or non-
defective (N).
✓ Here is the sample space: (D,D)
✓ The random variable X is (D,N)
(N,D)
the number of defective shirts.
(N,N)
✓ The possible number of
defective shirts is the set X = {0, 1, 2}.
• Since these are the only possible outcomes, X is a discrete
random variable.
LO 5.1
 Random Variables and Discrete
Probability Distributions….

• Every random variable is associated with a probability distribution

that describes the variable completely.
• A probability mass function is used to describe discrete random
variables.
• A probability density function is used to describe continuous
random variables.
• A cumulative distribution function may be used to describe either
discrete or continuous random variables.
LO 5.1
 Random Variables and Discrete
Probability Distributions….
• The probability mass function for a discrete random
variable X is a list of the values of X with the associated
probabilities, that is, the list of all possible pairs:

( x, P ( X = x ) )
• The cumulative distribution function for X is defined
as:
P ( X  x)
LO 5.1
Random Variables and Discrete Probability
Distributions….
• Two key properties of discrete probability
distributions:
✓ The probability of each value x is a value between
0 and 1, or equivalently:

0  P ( X = x)  1

✓ The sum of the probabilities equals 1. In other words:

åP (X = x ) = 1
i

where the sum extends over all values x of X.

LO 5.1
 Random Variables and Discrete
Probability Distributions…
• A discrete probability distribution may be viewed in
a tabular, algebraic, or graphical forms.
• For example, consider the experiment of rolling a six-
sided die. The probability distribution is:
x 1 2 3 4 5 6
P(X = x) 1/6 1/6 1/6 1/6 1/6 1/6

• Each outcome has an associated probability of 1/6.

Thus, the pairs of values and their probabilities form
the probability mass function for X.
LO 5.1
 Random Variables and Discrete
Probability Distributions….
• Another tabular view of a probability distribution is
based on the cumulative probability distribution.
• For example, consider the experiment of rolling a six-
sided die. The cumulative probability distribution:
x 1 2 3 4 5 6

P(X ≤ x) 1/6 2/6 3/6 4/6 5/6 6/6

• The cumulative probability distribution gives the

probability that X is less than or equal to x.
For example, P ( X  4 ) = 4 6
LO 5.1
 Random Variables and Discrete
Probability Distributions…
• A probability distribution may be expressed with
algebraic formula.
• For example, for the six-sided die experiment, the
probability distribution for the random variable X is:
1 6 if x = 1,2,3,4,5,6
P ( X = x) = 
0 otherwise
• Using this formula, we can find
P ( X = 5) = 1 6 P ( X = 7) = 0
LO 5.1
 Random Variables and Discrete
Probability Distributions (10)
• A probability distribution may be shown graphically.
✓ The values x of X are placed on the horizontal axis and the
probabilities P(X = x) on the vertical axis.
✓ A line is drawn so that its height equals P(X = x).
✓ For example, here is the
graph representing the
six-sided die experiment:
✓ This is a discrete uniform
distribution since the bar
heights are all the same.
LO 5.1
Random Variables and Discrete
Probability Distributions….
• Example: Consider the probability distribution
that reflects the number of homes that a realtor sells
over a one-month period:
✓ Is this a valid probability
distribution?
✓ What is the probability that the
realtor does not sell any houses?
✓ What is the probability that the realtor sells at most one
house?
✓ What is the probability that the realtor sells at least two
houses?
LO 5.1
 Random Variables and Discrete
Probability Distributions..
• Consider the probability distribution that reflects the
number of homes that a realtor sells over a one-
month period:
✓ Yes, because 0 < P(X = x) < 1
and P(X = x) = 1.
✓ P(X = 0) = 0.30
✓ P(X ≤ 1) = P(X = 0) + P(X = 1)
= 0.30 + 0.50 = 0.80.
✓ P(X > 2) = P(X = 2) + P(X = 3)
= 0.15 + 0.05 = 0.20.
Alternatively, P(X > 2) = 1 − P(X ≤ 1) = 1 − 0.80 = 0.20.
LO 5.1
Expected Value, Variance, and Standard
Deviation..
• Summary measures for a random variable
include the
✓ Mean (Expected Value)
✓ Variance
✓ Standard Deviation

LO 5.2
Expected Value, Variance, and Standard
Deviation…
• Expected Value Population Mean
E(X) μ
✓ E(X) is the long-run average value of the random variable
over infinitely many independent repetitions of an
experiment.
✓ For a discrete random variable X with values x1, x2, x3,…
that occur with probabilities P(X = xi), the expected value
of X is the probability weighted average of the values:

E ( X ) =  =  xi P ( X = x i )
LO 5.2
 Expected Value, Variance, and Standard
Deviation….
• Variance and Standard Deviation
✓ For a discrete random variable X with values x1, x2, x3, … that occur with
probabilities P(X = xi), the variance is defined as:

𝑉𝑎𝑟 𝑋 = 𝜎 2 = ෍ 𝑥𝑖 − 𝜇 2 𝑃(𝑋 = 𝑥)

✓ The standard deviation is the square root of the variance:

SD ( X ) =  =  2

LO 5.2
Expected Value, Variance, and Standard
Deviation..
• Example: Brad Williams, owner of a car dealership in
Chicago, decides to construct an incentive
compensation program based on performance.

✓ Calculate the expected value of the annual bonus amount.

✓ Calculate the variance and standard deviation of the
annual bonus amount.

LO 5.2
Expected Value, Variance, and Standard
Deviation..
• Solution: Let the random variable X denote the bonus
amount (in $1,000s) for an employee.

✓✓ . E(X) = 𝜇 = Σ x P(X = x ) = 4.2, or $4,200

i i

✓ Var(X) = 𝜎2 = Σ (xi − 𝜇)2P(X = xi) = 9.97, or 9.97 (in ($1,000s)2)

✓ SD(X) = σ = = 3.158, or $3,158

LO 5.2
 Expected Value, Variance, and
Standard Deviation..
• Risk Neutrality and Risk Aversion
✓ Risk-averse consumers:
• Demand positive expected gain as compensation for
taking risk.
• May decline a risky prospect even if it offers a positive
expected gain.
✓ Risk-neutral consumers:
• Completely ignore risk.
• Always accept a prospect that offers a positive expected
gain.
✓ Risk-loving consumers:
• May accept a risky prospect even if the expected gain is
negative.
LO 5.2
 Expected Value, Variance, and
Standard Deviation…
• Application of Expected Value to Risk
✓ Suppose you have a choice of receiving $1,000 in cash
or receiving a beautiful painting from your grandmother.
✓ The actual value of the painting is uncertain. Here is a
probability distribution of the
possible worth of the painting.
What should you do?
✓ First, calculate the expected value:

✓ Expected value > $1,000 it may seem logical to choose the

painting. But a risk-averse person might not agree.
LO 5.2
Portfolio Returns..
• Investment opportunities often use:
✓ Expected return as a measure of reward.
✓ Variance or standard deviation of return as a measure of risk.
• A portfolio is defined as a collection of assets such as
stocks and bonds.
✓ Let X and Y represent two random variables of interest, denoting
the returns of two assets.
✓ If an investor has invested in both assets, we want to evaluate
the return generated by the portfolio, which is a linear
combination of X and Y.

LO 5.3
 Portfolio Returns
• Properties of random variables useful in evaluating
portfolio returns.
✓ Given two random variables X and Y,
• The expected value of their sum is
E ( X + Y ) = E ( X ) + E (Y )
• The variance of their sum is
Var ( X + Y ) = Var ( X ) + Var (Y ) + 2Cov ( X ,Y )
where Cov(X,Y) is the covariance between X and Y.
• For constants a, b, the formulas extend to
E ( aX + bY ) = aE ( X ) + bE (Y )
Var ( aX + bY ) = a2Var ( X ) + b2Var (Y ) + 2abCov ( X ,Y )
LO 5.3
Portfolio Returns
• Expected return, variance, and standard
deviation for a portfolio.
✓ Given a portfolio with two assets, Asset A and
Asset B, the expected return of the portfolio E(Rp)
is computed as:
E ( Rp ) = w AE ( RA ) + w BE ( RB )

• wA and wB are the portfolio weights (wA + wB = 1).

• E(RA) and E(RB) are the expected returns on assets A and
B, respectively.

LO 5.3
 Portfolio Returns
• Expected return, variance, and standard
deviation for a portfolio.
✓ The portfolio variance Var(Rp) is computed as:
Var ( Rp ) = w A 2 A 2 + w B 2 B 2 + 2w Aw B  AB A B

• A2 and B 2are the variances for Asset A and Asset B.

• 𝜎AB is the covariance between Asset A and Asset B.
• ρ AB is the correlation coefficient between the returns for
Asset A and Asset B.

LO 5.3
Portfolio Returns
• Expected return, variance, and standard
deviation for a portfolio.
✓ The portfolio standard deviation SD(Rp) is computed
as the positive square root of the portfolio variance:

LO 5.3
 Portfolio Returns..
• Example: Consider an investment portfolio of
$40,000 in Stock A and $60,000 in Stock B.
✓ Given the following information, calculate the expected
return of this portfolio.

LO 5.3
 Portfolio Returns..
• Example: Consider an investment portfolio of
$40,000 in Stock A and $60,000 in Stock B.

✓ Calculate the correlation coefficient between the

returns on Stocks A and B:

LO 5.3
 Portfolio Returns..
• Example: Consider an investment portfolio of
$40,000 in Stock A and $60,000 in Stock B.

✓ Calculate the portfolio variance:.

LO 5.3
 Portfolio Returns
• Example: Consider an investment portfolio of
$40,000 in Stock A and $60,000 in Stock B.

✓ Calculate the portfolio standard deviation.

LO 5.3
The Binomial Distribution

• A binomial random variable is defined as the number of successes achieved in the n

trials of a Bernoulli process.
• A Bernoulli process consists of a series of n independent and identical trials of
an experiment such that on each trial:
• There are only two possible outcomes:
• Success: P(success) = p
• Failure: P(failure) = 1−p = q
• The probabilities of success and failure remain the same from trial to trial.

LO 5.4
 The Binomial Distribution..
• A binomial random variable X is defined as the number
of successes achieved in the n trials of a Bernoulli
process.
• A binomial probability distribution shows the
probabilities associated with the possible values of the
binomial random variable (that is, 0, 1, . . . , n).
✓ For a binomial random variable X , the probability of x
successes in n Bernoulli trials is:

( )
P ( X = x ) = nx p x q n − x =
n!
x ! ( n − x )!
p xq n−x

for x = 0,1,2, … , n. By definition, 0! = 1.

LO 5.4
 The Binomial Distribution
• For a binomial distribution:

✓ The expected value (E(X)) is: E(X) = µ = np

✓ The variance (Var(X)) is: Var ( X ) =  2 = npq

✓ The standard deviation (SD(X)) is: SD ( X ) =  = npq

LO 5.4
 The Binomial Distribution
Example: In the United States, about 30% of adults have
four-year college degrees. Suppose 5 adults are
randomly selected.
✓ What is the probability that none of the adults has
a college degree?
• Solution: Let x = 0, then

LO 5.4
 The Binomial Distribution
• Computing binomial probabilities with Excel:
✓ According to a 2016 Pew Research survey, 68% of all U.S. adults are Facebook users.
Consider a sample of 100 randomly selected U.S. adults.
• What is the probability that 70 adults are Facebook users?
• What is the probability that no more than 70 adults are Facebook users?
• What is the probability that at least 70 adults are Facebook users?

✓ Understanding the Excel:

• Number_s - # of successes (# Facebook users)
• Trials - # trials (# adults in sample)
• P_success – probability of success (0.68 chance of success per trial)
• Cumulative – 0 or 1 (0 is for non-cumulative; 1 is for cumulative)

LO 5.4
 The Poisson Distribution

• A binomial random variable counts the number of successes in a

fixed number of Bernoulli trials.
• A Poisson random variable counts the number of successes over
a given interval of time or space.
• Examples of a Poisson random variable include:
✓ With respect to time—the number of cars that cross the Brooklyn
Bridge between 9:00 am and 10:00 am on a Monday morning.
✓ With respect to space—the number of defects in a
50-yard roll of fabric.

LO 5.5
 The Poisson Distribution.
• An experiment is a Poisson process if:
✓ The number of successes within a specified time
or space interval equals any integer between zero
and infinity.
✓ The numbers of successes counted in non-
overlapping intervals are independent.
✓ The probability of success in any interval is the
same for all intervals of equal size and is
proportional to the size of the interval.

LO 5.5
 The Poisson Distribution..
• For a Poisson random variable X, the
probability of x successes over a given
interval of time or space is
−
e  x
P ( X = x) = for x = 0,1,2 ,…,
x!
where µ is the mean number of successes
and e ≈ 2.718 is the base of the natural
logarithm.
LO 5.5
 The Poisson Distribution
• For a Poisson distribution:

✓ The expected value (E(X)) is: E(X) = µ

✓ The variance (Var(X)) is: Var ( X ) =  2 = 

✓ The standard deviation (SD(X)) is: SD ( X ) =  = 

LO 5.5
 The Poisson Distribution..
• Example: Returning to the Starbucks example, Ann
believes that the typical Starbucks customer averages 18
visits over a 30-day month.
✓ How many visits should Anne expect in a 5-day period from a
typical Starbucks customer?lution:

✓ What is the probability that a customer visits the chain five times
in a 5-day period?

LO 5.5
The Poisson Distribution
• Computing Poisson probabilities with Excel:
✓ It has been estimated that 1.5 craft breweries open every day. Assume this
number represents an average that remains constant over time.
• What is the probability that no more than 10 breweries open every week?
• What is the probability that exactly 10 craft breweries open every week?
• Let X denote the number of breweries that open every week and compute
the weekly mean, μ = 1.5 × 7 = 10.5.

✓ Understanding the Excel:

• x - # of successes over some interval (# opened breweries)
• mean - mean over this interval (10.5 every week)
• cumulative – 0 or 1 (0 is for non-cumulative; 1 is for cumulative)

LO 5.5
 The Hypergeometric Distribution

• A binomial random variable X is defined as the number of

successes in the n trials of a Bernoulli process, and
according to a Bernoulli process, those trials are
✓ Independent and
✓ The probability of success does not change from trial to
trial.
• The hypergeometric probability distribution is
appropriate in applications where we cannot assume the
trials are independent.
LO 5.6
 The Hypergeometric Distribution..
• Use the hypergeometric distribution when sampling without
replacement from a population whose size N is not significantly
larger than the sample size n.
✓ For a hypergeometric random variable X, the probability of x successes
in a random selection of n items is

P ( X = x) =
( )( )
S
x
N −S
n−x

( )
N
n
for x = 0,1,2, … , n if n  S or x = 0,1,2, …, S if n  S,

where N denotes the number of items in the population of which S are

successes.

LO 5.6
 The Hypergeometric Distribution..
• For a hypergeometric distribution:
✓ The expected value (E(X)) is:
S
E (X ) =  = n 
N 

✓ The variance (Var(X)) is:

 S  S  N − n 
Var ( X ) =  2 = n    1 −   
 N  N  N −1 

✓ The standard deviation (SD(X)) is:

 S  S  N − n 
SD ( X ) =  = n   1 −  
 N  N  N − 1 

LO 5.6
 The Hypergeometric Distribution …
• Example: At a convenience store in Morganville, New
Jersey, the manager randomly inspects five mangoes
from a box containing 20 mangoes for damages due
to transportation. Suppose the chosen box contains
exactly 2 damaged mangoes.
✓ What is the probability that one out of five mangoes used in
the inspection is damaged?
✓ Solution

LO 5.6
The Hypergeometric Distribution..
• Computing Hypergeometric probabilities with Excel:
✓ Among 25 applicants for a management position, 15 have college degrees in
business. Suppose four applicants are randomly chosen for interviews.
• Let X denote the number of applicants with a college degree in business. We
know that n = 4, S = 15, and N = 25.
• What is the probability that none of the applicants has a business degree?
• What is the probability that no more than 2 of the applicants have college
degrees in business?

✓ Understanding the Excel:

• Sample_s – # of successes in the sample
• Number_sample – sample size (four applicants)
• Population_s – # of successes in the population (15 applicants)
• Number_pop – population size (25 applicants)
• Cumulative – 0 or 1 (0 is for non-cumulative; 1 is for cumulative)

LO 5.6
The Hypergeometric Distribution..
• Computing Hypergeometric probabilities with R:
✓ Among 25 applicants for a management position, 15 have college
degrees in business. Suppose four applicants are randomly chosen for
interviews.
• Let X denote the number of applicants with a college degree in
business. We know that n = 4, S = 15, and N = 25.
• What is the probability that none of the applicants has a business
degree?

> dhyper(0,15,10,4)

• What is the probability that no more than 2 of the applicants have

college degrees in business?

> phyper(2,15,10,4)
LO 5.6
Discrete Probability Distributions and
Function Names in Excel and R