[Math] Variance using moment

expectationmoment-generating-functionsprobabilityvariance

In a group of 15 health insurance policyholders diagnosed with cancer, each policyholder has probability 0.90 of receiving radiation and probability 0.40 of receiving chemotherapy. Radiation and chemotherapy treatments are independent events for each policyholder, and the treatments of different policyholders are mutually independent.

The policyholders in this group all have the same health insruacne that pays 2 for ardiation treatment and 3 for chemotherapy treatment.

Calcualte the variance of the total amount the insurance company pays for the radiation and chemotherapy treatments for these 15 policyholders.

After reading through this question, I attempted to use the formula $$Var(x) = E(x^2)-E(x)^2$$ which I have $$Var(x)=(2^2 * 0.9 + 3^2*0.4) – (2*0.9+3*0.4)^2=-1.8$$ And I stopped there.

I understand the solution, which uses binomial distribution to find out two variances: $15*0.9*0.1=1.35$ and $15*0.4*0.6=3.6$, then calculate variance $4*1.35+9*3.6=37.8$ But I am not sure why using the identity does not work. Thanks for helping!

Best Answer

The problem is the radiation and chemotherapy are not mutually exclusive. So by independence, you have a $0.9\cdot 0.4=0.36$ probability to have both radiation and chemotherapy. So you have:

$0.36=0.9\cdot 0.4$ probability for both radiation and chemotherapy (cost $2+3=5$)

$0.04=0.40-0.36$ probability for chemotherapy only (cost $3$)

$0.54=0.9-0.36$ probability for radiation only (cost 2)

$0.06=1-0.36-0.04-0.54$ probability for neither radiation nor chemotherapy (cost 0)

So for one patient, the variance is:

$5^2\cdot 0.36+3^2\cdot 0.04 + 2^2\cdot 0.54 - (5\cdot 0.36+3\cdot 0.04 + 2\cdot 0.54)^2 = 2.52$

For all patients, the variance is (by independence): $15\cdot 2.52 = 37.8$

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