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    Variance, Covariance, and Moment-Generating Functions: Practice Problems - Solutions

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    Li Nguyen
    This document contains solutions to 5 practice problems from a course on actuarial statistics: 1. If a 20% tax is introduced on car maintenance costs, the variance of costs increases from 260 to 374. 2. For a new product where profit is defined as Z = 3X - Y - 5, the variance of profit is 11 if the variances of X and Y are 1 and 2 respectively. 3. If the variances of medical benefits paid to a surgeon (X) and hospital (Y) are increased, the new variance of total benefits is 19,520. 4. The expected value of the cube of combined losses (X) from insuring homes in 3 cities is

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    Variance, Covariance, and Moment-Generating Functions: Practice Problems - Solutions

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    Li Nguyen
    52 views2 pages
    This document contains solutions to 5 practice problems from a course on actuarial statistics: 1. If a 20% tax is introduced on car maintenance costs, the variance of costs increases from 260 to 374. 2. For a new product where profit is defined as Z = 3X - Y - 5, the variance of profit is 11 if the variances of X and Y are 1 and 2 respectively. 3. If the variances of medical benefits paid to a surgeon (X) and hospital (Y) are increased, the new variance of total benefits is 19,520. 4. The expected value of the cube of combined losses (X) from insuring homes in 3 cities is

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    Variance problems and sols

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    408 Variance Sol

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    This document contains solutions to 5 practice problems from a course on actuarial statistics: 1. If a 20% tax is introduced on car maintenance costs, the variance of costs increases from 260 to 374. 2. For a new product where profit is defined as Z = 3X - Y - 5, the variance of profit is 11 if the variances of X and Y are 1 and 2 respectively. 3. If the variances of medical benefits paid to a surgeon (X) and hospital (Y) are increased, the new variance of total benefits is 19,520. 4. The expected value of the cube of combined losses (X) from insuring homes in 3 cities is

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    © All Rights Reserved
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    Download as pdf or txt
    52 views2 pages

    Variance, Covariance, and Moment-Generating Functions: Practice Problems - Solutions

    Uploaded by

    Li Nguyen
    This document contains solutions to 5 practice problems from a course on actuarial statistics: 1. If a 20% tax is introduced on car maintenance costs, the variance of costs increases from 260 to 374. 2. For a new product where profit is defined as Z = 3X - Y - 5, the variance of profit is 11 if the variances of X and Y are 1 and 2 respectively. 3. If the variances of medical benefits paid to a surgeon (X) and hospital (Y) are increased, the new variance of total benefits is 19,520. 4. The expected value of the cube of combined losses (X) from insuring homes in 3 cities is

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    Math 408, Actuarial Statistics I A.J.

    Hildebrand

    Variance, covariance, and moment-generating functions

    Practice problems — Solutions

    1. Suppose that the cost of maintaining a car is given by a random variable, X, with mean
    200 and variance 260. If a tax of 20% is introducted on all items associated with the
    maintenance of the car, what will the variance of the cost of maintaining a car be?

    Solution: The new cost is 1.2X, so its variance is Var(1.2X) = 1.22 Var(X) = 1.44 ·
    260 = 374.

    2. The profit for a new product is given by Z = 3X −Y −5, where X and Y are independent
    random variables with Var(X) = 1 and Var(Y ) = 2. What is the variance of Z?

    Solution: Using the properties of a variance, and independence, we get

    Var(Z) = Var(3X−Y −5) = Var(3X−Y ) = Var(3X)+Var(−Y ) = 9 Var(X)+Var(Y ) = 11.

    3. An insurance policy pays a total medical benefit consisting of a part paid to the surgeon,
    X, and a part paid to the hospital, Y , so that the total benefit is X + Y . Suppose that
    Var(X) = 5, 000, Var(Y ) = 10, 000, and Var(X + Y ) = 17, 000.
    If X is increased by a flat amount of 100, and Y is increased by 10%, what is the variance
    of the total benefit after these increases?

    Solution: We need to compute Var(X + 100 + 1.1Y ). Since adding constants does not
    change the variance, this is the same as Var(X + 1.1Y ), which expands as follows:

    Var(X + 1.1Y ) = Var(X) + Var(1.1Y ) + 2 Cov(X, 1.1Y ) = Var(X) + 1.12 Var(Y ) + 2 · 1.1 Cov(X, Y ).

    We are given that Var(X) = 5, 000, Var(Y ) = 10, 000, so the only remaining unknown
    quantity is Cov(X, Y ), which can be computed via the general formula for Var(X + Y ):
    1 1
    Cov(X, Y ) = (Var(X + Y ) − Var(X) − Var(Y )) = (17, 000−5, 000−10, 000) = 1, 000.
    2 2
    Substituting this into the above formula, we get the answer:

    Var(X + 1.1Y ) = 5, 000 + 1.12 · 10, 000 + 2 · 1.1 · 1, 000 = 19, 520

    4. A company insures homes in three cities, J, K, L. The losses occurring in these cities are
    independent. The moment-generating functions for the loss distributions of the cities
    are
    MJ (t) = (1 − 2t)−3 , MK (t) = (1 − 2t)−2.5 , ML (t) = (1 − 2t)−4.5
    Let X represent the combined losses from the three cities. Calculate E(X 3 ).
    Solution: Let J, K, L denote the losses from the three cities. Then X = J + K + L.

    1
    Math 408, Actuarial Statistics I A.J. Hildebrand

    Since J, K, L are independent, the moment-generating function for their sum, X, is


    equal to the product of the individual moment-generating functions, i.e.,

    MX (t) = MK (t)MJ (t)ML (t) = (1 − 2t)−3−2.5−4.5 = (1 − 2t)−10 .

    Differentiating this function, we get

    M 0 (t) = (−2)(−10)(1 − 2t)−11 ,


    M 00 (t) = (−2)2 (−10)(−11)(1 − 2t)−12 ,
    M 000 (t) = (−2)3 (−10)(−11)(−12)(1 − 2t)−13 .
    000 (0) = (−2)3 (−10)(−11)(−12) = 10, 560.
    Hence, E(X 3 ) = MX

    5. Given that E(X) = 5, E(X 2 ) = 27.4, E(Y ) = 7, E(Y 2 ) = 51.4 and Var(X + Y ) = 8,
    find Cov(X + Y, X + 1.2Y ).

    Solution: By definition,

    Cov(X + Y, X + 1.2Y ) = E((X + Y )(X + 1.2Y )) − E(X + Y )E(X + 1.2Y ).

    Using the properties of expectation and the given data, we get

    E(X + Y )E(X + 1.2Y ) = (E(X) + E(Y ))(E(X) + 1.2E(Y )) = (5 + 7)(5 + 1.2 · 7) = 160.8,
    E((X + Y )(X + 1.2Y )) = E(X 2 ) + 2.2E(XY ) + 1.2E(Y 2 )
    = 27.4 + 2.2E(XY ) + 1.2 · 51.4 = 2.2E(XY ) + 89.08,
    Cov(X + Y, X + 1.2Y ) = 2.2E(XY ) + 89.08 − 160.8 = 2.2E(XY ) − 71.72

    To complete the calculation, it remains to find E(XY ). To this end we make use of the
    still unused relation Var(X + Y ) = 8:

    8 = Var(X + Y ) = E((X + Y )2 ) − (E(X + Y ))2 = E(X 2 ) + 2E(XY ) + E(Y 2 ) − (E(X) + E(Y ))2
    = 27.4 + 2E(XY ) + 51.4 − (5 + 7)2 = 2E(XY ) − 65.2,

    so E(XY ) = 36.6. Substituting this above gives Cov(X + Y, X + 1.2Y ) = 2.2 · 36.6 −
    71.72 = 8.8.

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