CHAPTER 3

Basic Statistics

In this chapter we will learn how to describe a collection of data in precise statistical terms. Many of the concepts will be familiar, but the notation and terminology might be new. This notation and terminology will be used throughout the rest of the book.

AVERAGES

Everybody knows what an average is. We come across averages every day, whether they are earned run averages in baseball or grade point averages in school. In statistics there are actually three different types of averages: means, modes, and medians. By far the most commonly used average in risk management is the mean.

Population and Sample Data

If you wanted to know the mean age of people working in your firm, you would simply ask every person in the firm his or her age, add the ages together, and divide by the number of people in the firm. Assuming there are n employees and ai is the age of the ith employee, then the mean, μ, is simply:

It is important at this stage to differentiate between population statistics and sample statistics. In this example, μ is the population mean. Assuming nobody lied about his or her age, and forgetting about rounding errors and other trivial details, we know the mean age of people in your firm exactly. We have a complete data set of everybody in your firm; we've surveyed the entire population.

This state of absolute certainty is, unfortunately, quite ...