Question

Consider a probability space $\Omega$ with four elements, which we call $a, b, c$, and $d$ (i.e., $\Omega=\{a, b, c, d\}$ ). The $\sigma$-algebra $\mathcal{F}$ is the collection of all subsets of $\Omega$; i.e., the sets in $\mathcal{F}$ are $$ \begin{aligned} & \Omega,\{a, b, c\},\{a, b, d\},\{a, c, d\},\{b, c, d\}, \\ & \{a, b\},\{a, c\},\{a, d\},\{b, c\},\{b, d\},\{c, d\}, \\ & \{a\},\{b\},\{c\},\{d\}, \emptyset . \end{aligned} $$ We define a probability measure $\mathbb{P}$ by specifying that $$ \mathbb{P}\{a\}=\frac{1}{6}, \mathbb{P}\{b\}=\frac{1}{3}, \mathbb{P}\{c\}=\frac{1}{4}, \mathbb{P}\{d\}=\frac{1}{4}, $$ and, as usual, the probability of every other set in $\mathcal{F}$ is the sum of the probabilities of the elements in the set, e.g., $\mathbb{P}\{a, b, c\}=\mathbb{P}\{a\}+\mathbb{P}\{b\}+\mathbb{P}\{c\}=\frac{3}{4}$. We next define two random variables, $X$ and $Y$, by the formulas $$ \begin{aligned} & X(a)=1, X(b)=1, X(c)=-1, X(d)=-1, \\ & Y(a)=1, Y(b)=-1, Y(c)=1, Y(d)=-1 . \end{aligned} $$ We then define $Z=X+Y$. (i) List the sets in $\sigma(X)$. (ii) Determine $\mathbb{E}[Y \mid X]$ (i.e., specify the values of this random variable for $a$, $b, c$, and $d$ ). Verify that the partial-averaging property is satisfied. (iii) Determine $\mathbb{E}[Z \mid X]$. Again, verify the partial-averaging property. (iv) Compute $\mathbb{E}[Z \mid X]-\mathbb{E}[Y \mid X]$. Citing the appropriate properties of conditional expectation from Theorem 2.3.2, explain why you get $X$.

    Consider a probability space $\Omega$ with four elements, which we call $a, b, c$, and $d$ (i.e., $\Omega=\{a, b, c, d\}$ ). The $\sigma$-algebra $\mathcal{F}$ is the collection of all subsets of $\Omega$; i.e., the sets in $\mathcal{F}$ are
$$
\begin{aligned}
& \Omega,\{a, b, c\},\{a, b, d\},\{a, c, d\},\{b, c, d\}, \\
& \{a, b\},\{a, c\},\{a, d\},\{b, c\},\{b, d\},\{c, d\}, \\
& \{a\},\{b\},\{c\},\{d\}, \emptyset .
\end{aligned}
$$

We define a probability measure $\mathbb{P}$ by specifying that
$$
\mathbb{P}\{a\}=\frac{1}{6}, \mathbb{P}\{b\}=\frac{1}{3}, \mathbb{P}\{c\}=\frac{1}{4}, \mathbb{P}\{d\}=\frac{1}{4},
$$
and, as usual, the probability of every other set in $\mathcal{F}$ is the sum of the probabilities of the elements in the set, e.g., $\mathbb{P}\{a, b, c\}=\mathbb{P}\{a\}+\mathbb{P}\{b\}+\mathbb{P}\{c\}=\frac{3}{4}$.
We next define two random variables, $X$ and $Y$, by the formulas
$$
\begin{aligned}
& X(a)=1, X(b)=1, X(c)=-1, X(d)=-1, \\
& Y(a)=1, Y(b)=-1, Y(c)=1, Y(d)=-1 .
\end{aligned}
$$

We then define $Z=X+Y$.
(i) List the sets in $\sigma(X)$.
(ii) Determine $\mathbb{E}[Y \mid X]$ (i.e., specify the values of this random variable for $a$, $b, c$, and $d$ ). Verify that the partial-averaging property is satisfied.
(iii) Determine $\mathbb{E}[Z \mid X]$. Again, verify the partial-averaging property.
(iv) Compute $\mathbb{E}[Z \mid X]-\mathbb{E}[Y \mid X]$. Citing the appropriate properties of conditional expectation from Theorem 2.3.2, explain why you get $X$.

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Stochastic Calculus for Finance II : Continuous-Time Models
Stochastic Calculus for Finance II : Continuous-Time Models
Steven E. Shreve 1st Edition
Chapter 2, Problem 6 ↓

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Step 1

To list the sets in $\sigma(X)$, we need to identify the subsets of $\Omega$ that can be determined by the values of $X$. Since $X(a) = X(b) = 1$ and $X(c) = X(d) = -1$, the $\sigma$-algebra generated by $X$, denoted $\sigma(X)$, consists of the sets that can be  Show more…

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Consider a probability space $\Omega$ with four elements, which we call $a, b, c$, and $d$ (i.e., $\Omega=\{a, b, c, d\}$ ). The $\sigma$-algebra $\mathcal{F}$ is the collection of all subsets of $\Omega$; i.e., the sets in $\mathcal{F}$ are $$ \begin{aligned} & \Omega,\{a, b, c\},\{a, b, d\},\{a, c, d\},\{b, c, d\}, \\ & \{a, b\},\{a, c\},\{a, d\},\{b, c\},\{b, d\},\{c, d\}, \\ & \{a\},\{b\},\{c\},\{d\}, \emptyset . \end{aligned} $$ We define a probability measure $\mathbb{P}$ by specifying that $$ \mathbb{P}\{a\}=\frac{1}{6}, \mathbb{P}\{b\}=\frac{1}{3}, \mathbb{P}\{c\}=\frac{1}{4}, \mathbb{P}\{d\}=\frac{1}{4}, $$ and, as usual, the probability of every other set in $\mathcal{F}$ is the sum of the probabilities of the elements in the set, e.g., $\mathbb{P}\{a, b, c\}=\mathbb{P}\{a\}+\mathbb{P}\{b\}+\mathbb{P}\{c\}=\frac{3}{4}$. We next define two random variables, $X$ and $Y$, by the formulas $$ \begin{aligned} & X(a)=1, X(b)=1, X(c)=-1, X(d)=-1, \\ & Y(a)=1, Y(b)=-1, Y(c)=1, Y(d)=-1 . \end{aligned} $$ We then define $Z=X+Y$. (i) List the sets in $\sigma(X)$. (ii) Determine $\mathbb{E}[Y \mid X]$ (i.e., specify the values of this random variable for $a$, $b, c$, and $d$ ). Verify that the partial-averaging property is satisfied. (iii) Determine $\mathbb{E}[Z \mid X]$. Again, verify the partial-averaging property. (iv) Compute $\mathbb{E}[Z \mid X]-\mathbb{E}[Y \mid X]$. Citing the appropriate properties of conditional expectation from Theorem 2.3.2, explain why you get $X$.
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Key Concepts

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Sigma-Algebra
A sigma-algebra is a collection of subsets of a sample space that is closed under complementation and countable unions. It defines the collection of events for which probabilities can be assigned and is fundamental in constructing measures on a space.
Random Variable
A random variable is a measurable function from a sample space to the real numbers. Its measurability ensures that the pre-image of any Borel set is an event in the sigma-algebra, allowing probabilities to be defined for its outcomes.
Sigma-Algebra Generated by a Random Variable
The sigma-algebra generated by a random variable consists of all the events that can be described in terms of the values of that random variable. It represents all the information contained in the variable and underpins concepts like conditioning on the variable.
Conditional Expectation
Conditional expectation is the expected value of a random variable given a sigma-algebra or another random variable. It generalizes the concept of conditioning by providing an 'averaged' version of the random variable that is measurable with respect to the given sigma-algebra.
Partial-Averaging Property
The partial-averaging property of conditional expectation states that the conditional expectation, when integrated over any event in the conditioning sigma-algebra, reproduces the integral of the original random variable over that event. This property is key to verifying that a candidate function truly represents a conditional expectation.
Properties of Conditional Expectation
Conditional expectation satisfies several important properties such as linearity, measurability with respect to the conditioning sigma-algebra, and the tower property. These properties are invaluable for simplifying expressions and performing calculations in probability and measure theory.

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Consider a probability space with four elements, which we will call a, b, c, and d (i.e. ̩̐ = {a, b, c, d}). The ̩̐-algebra F is the collection of all subsets of ̩̐; i.e., the sets in F are: ̩̐, {a, b, c}, {a, b, d}, {a, c, d}, {b, c, d}, {a, b}, {a, c}, {a, d}, {b, c}, {b, d}, {c, d}, {a}, {b}, {c}, {d}, ∅. We define a probability measure P by specifying that P({a}) = 1/6, P({b}) = 1/3, P({c}) = 1/4, P({d}) = 1/4. We next define two random variables, X and Y, by the following formulas: X(a) = 1, X(b) = 1, X(c) = -1, X(d) = -1 Y(a) = 1, Y(b) = -1, Y(c) = 1, Y(d) = -1. We then define Z = X + Y. List the sets in ̩̐(X). Determine E[Y|X]. Verify that the partial averaging property is satisfied. That is, show that E[I_A E[Y|X]] = E[I_A Y] for all A ∈ ̩̐(X).

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Exercise 2.6. Consider a probability space  with four elements, which we call a, b, c, and d (i.e.,  = {a, b, c, d}). The -algebra F is the collection of all subsets of ; i.e., the sets in F are {, {a, b, c}, {a, b, d}, {a, c, d}, {b, c, d}, {a, b}, {a, c}, {a, d}, {b, c}, {b, d}, {c, d}, {a}, {b}, {c}, {d}}. We define a probability measure P by specifying that P(a) = 1/4, P(b) = 1/3, P(c) = 1/4, P(d) = 1/4, and, as usual, the probability of every other set in F is the sum of the probabilities of the elements in the set, e.g., P({a, b, c}) = P(a) + P(b) + P(c) = 4/12 = 1/3. We next define two random variables X and Y, by the formulas X(a) = 1, X(b) = 1, X(c) = -1, X(d) = -1, Y(a) = 1, Y(b) = -1, Y(c) = 1, Y(d) = -1. We then define Z = X + Y.

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