A and B have same distribution of loss as follow: Outcome $20,000 Probability Lo

Question

A and B have same distribution of loss as follow: Outcome $20,000 Probability Loss 0.01 Outcome $0 Probability Loss 0.99 1. Calculate the expected loss and expected standard deviation for either A or B 2. Suppose A and B agree to split evenly any loss that the two might suffer. Assume that the losses A and B suffer are uncorrelated. Show that the risk is reduced, while the expected loss remains the same by calculating: E(loss under pooling arrangement), E(Standard deviation of loss under fooling arrangement). 3. Assume that the correlation of losses between A and B is measured at (1) 0.75 and (2) -0.85. Calculate the E(standard deviation of loss under fooling arrangement) under each of the two correlation situations just given. Note that in generally , Var[(x+y)/2]=1/2 var (x)*[1+rho(x,y)] where (x,y) is the correlation coefficient.

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http://finance.wharton.upenn.edu/~aedmans/612 PS.pdf

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