Expected Value

In probability theory, the expected value refers, intuitively, to the value of a random variable one would "expect" to find if one could repeat the random variable process an infinite number of times and take the average of the values obtained. More formally, the expected value is a weighted average of all possible values. In other words, each possible value the random variable can assume is multiplied by its assigned weight, and the resulting products are then added together to find the expected value.

The weights used in computing this average are the probabilities in the case of a discrete random variable (that is, a random variable that can only take on a finite number of values, such as a roll of a pair of dice), or the values of a probability density function in the case of a continuous random variable (that is, a random variable that can assume a theoretically infinite number of values, such as the height of a person).

From a rigorous theoretical standpoint, the expected value of a continuous variable is the integral of the random variable with respect to its probability measure. Since probability can never be negative (although it can be zero), one can intuitively understand this as the area under the curve of the graph of the values of a random variable multiplied by the probability of that value. Thus, for a continuous random variable the expected value is the limit of the weighted sum, i.e. the integral.

Simple Example

Suppose we have a random variable $X$, which represents the number of girls in a family of three children. Without too much effort, you can compute the following probabilities:

$P[X=0] = 0.125 \\ P[X=1] = 0.375 \\ P[X=2] = 0.375 \\ P[X=3] = 0.125$

The expected value of $X, E[X]$, is computed as:

$\displaystyle {\begin{aligned} E[X] &= \sum_{x=0}^3xP[X=x] \\ &=0\cdot 0.125 + 1\cdot0.375 + 2\cdot 0.375 + 3\cdot 0.125 \\ &= 1.5\end{aligned}}$

This calculation can be easily generalized to more complicated situations. Suppose that a rich uncle plans to give you $2,000 for each child in your family, with a bonus of$500 for each girl. The formula for the bonus is:

$Y = 1000 + 500X$

What is your expected bonus?

$\displaystyle {\begin{aligned} E[1000 + 500X] &= \sum_{x=0}^3 (1000 + 500x)P[X=x] \\ &=1000\cdot0.125 +1500\cdot0.375 + 2000\cdot0.375 + 2500 \cdot 0.125 \\ &= 1750 \end{aligned}}$

We could have calculated the same value by taking the expected number of children and plugging it into the equation:

$E[1000+500X] = 1000 + 500E[X]$

Expected Value and the Law of Large Numbers

The intuitive explanation of the expected value above is a consequence of the law of large numbers: the expected value, when it exists, is almost surely the limit of the sample mean as the sample size grows to infinity. More informally, it can be interpreted as the long-run average of the results of many independent repetitions of an experiment (e.g. a dice roll). The value may not be expected in the ordinary sense—the "expected value" itself may be unlikely or even impossible (such as having 2.5 children), as is also the case with the sample mean.

Uses and Applications

To empirically estimate the expected value of a random variable, one repeatedly measures observations of the variable and computes the arithmetic mean of the results. If the expected value exists, this procedure estimates the true expected value in an unbiased manner and has the property of minimizing the sum of the squares of the residuals (the sum of the squared differences between the observations and the estimate). The law of large numbers demonstrates (under fairly mild conditions) that, as the size of the sample gets larger, the variance of this estimate gets smaller.

This property is often exploited in a wide variety of applications, including general problems of statistical estimation and machine learning, to estimate (probabilistic) quantities of interest via Monte Carlo methods.

The expected value plays important roles in a variety of contexts. In regression analysis, one desires a formula in terms of observed data that will give a "good" estimate of the parameter giving the effect of some explanatory variable upon a dependent variable. The formula will give different estimates using different samples of data, so the estimate it gives is itself a random variable. A formula is typically considered good in this context if it is an unbiased estimator—that is, if the expected value of the estimate (the average value it would give over an arbitrarily large number of separate samples) can be shown to equal the true value of the desired parameter.

In decision theory, and in particular in choice under uncertainty, an agent is described as making an optimal choice in the context of incomplete information. For risk neutral agents, the choice involves using the expected values of uncertain quantities, while for risk averse agents it involves maximizing the expected value of some objective function such as a von Neumann-Morgenstern utility function.