R8 Probability Concepts 01

Chapter 8 - Probability Concepts

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1. Random Uncertain quantity or number 18. Covariance - A measure of how two assets move
Variable together
- The expected value, E(X), of two random
2. Outcome Observed value of a random variable
variables
3. Event Single outcome or group of outcomes - General concept as variance
4. Mutually Events that can't happen at the same time - May range from negative infinity to positive
Exclusive Events infinity (unbounded)
- Hard to interpret due to extreme values
5. Exhaustive Events are those that include all possible
Events outcomes 19. Covariance

6. 2 Defining 1) Probability of occurrence of an event

Properties of happening is between 0 and 1
20. Sample
Probability 2) If a set of events is mutually exclusive
Covariance
and exhaustive, sum must equal 1
7. Empirical - Established by analyzing past data
Probability - Known as an "objective probability"
21. Correlation - Easier interpretation of Covariance
8. Priori Probability - Determined by using formal reasoning Coefficient - Measures the strength of the linear
and inspection process (Corr) relationship between 2 variables
- Known as an "objective probability" - Has no units
9. Subjective - Least formal method used in probability - 1.0 = perfect positive correlation =
Probability - Involves using ones personal judgement proportionate positive movement with both
variables
10. Unconditional - Probability of an event regardless of
- -1.0 = perfect negative correlation = exact
Probability past or future occurrence
opposite movement with both variables
- Referred to as "marginal probability"
22. Portfolio
11. Conditional - One event will affect the probability of
Expected
Probability the occurrence of another event
Value
12. Multiplication - Used to determine the joint probability
23. Weight, Wᵢ
Rule of of two events
(Portfolio
Probability - P(AB) = P(A | B) × P(B)
Valuation)
13. Addition Rule of - Used to determine the probability that at
24. Portfolio Var (Rp) = Wₐ²σ²(Rᵥ) + Wᵥ²σ²(Rᵥ) +
Probability least one of two events will occur
Variance 2WₐWᵥCov(Rₐ,Rᵥ)
- P(A or B) = P(A) + P(B) − P(AB)
25. Bayes' Used to update a given set of prior
14. Total Probability Used to determine the unconditional
Formula probabilities for a given event in response to
Rule probability of an event, given conditional
new information
probabilities
26. Bayes'
15. Total Probability
Formula
Rule
27. Labeling - Situation where there are n items that can
16. Independent - Events for which the outcome doesn't
each receive on of k different labels
Events affect any other outcomes
- Applies to 3 or more subgroups of
- P(A | B) = P(A), or equivalently, P(B | A) =
predetermined size
P(B)
28. Labeling
17. Expected Value The weighted average of all of the
possible outcomes of a probability
distribution
- E(X) means Expected Value of X
- E(X) = ΣP(xᵢ)xᵢ = P(x₁)x₁ + P(x₂)x₂ + ... + 29. Combination - Situation for labeling when k = 2 instead of
P(xn)xn Formula 1
(binomial) - Applies to 2 groups of predetermined size,
key words are "choose" or "combination"
 R8 Probability Concepts 02

30. Combination Formula (binomial)

31. Permutation Formula - Specif ordering of a group objects

- Applies to only two groups of predetermined size, key is "order"
32. Permutation Formula