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Hi Brian:

I think I am missing something in David's notes on page 27:

On the very basic variance formula:

E[(Y - mu)^2] = E(Y^2) - [E(Y)]^2, if probability of loan default (PD) = p, then

Variance of PD is

E[PD^2] - (E[PD])^2, As E[PD^2] = p and E[PD] = p,

E[PD^2] - (E[PD])^2 = p - p^2 = p*(1-p)

How is it that E[PD^2] = p? What am I missing here?

Thanks!

Jayanthi

I think I am missing something in David's notes on page 27:

On the very basic variance formula:

E[(Y - mu)^2] = E(Y^2) - [E(Y)]^2, if probability of loan default (PD) = p, then

Variance of PD is

E[PD^2] - (E[PD])^2, As E[PD^2] = p and E[PD] = p,

E[PD^2] - (E[PD])^2 = p - p^2 = p*(1-p)

How is it that E[PD^2] = p? What am I missing here?

Thanks!

Jayanthi

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