Page 54 - FINAL CFA SLIDES DECEMBER 2018 DAY 3
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LOS 9.n: Calculate and interpret an Session Unit 2:
updated probability using Bayes’ 9. Probability Concepts
formula, p.191
BF is used to update a given set of prior probabilities for a given event in response to the arrival of
new information.
Example: Bayes’ formula (1): Electcomp Corporation manufactures electronic components for computers and other
r
devices. There is speculation that Electcomp is about to announce a major expansion into overseas markets. The
expansion will occur, however, only if Electcomp’s managers estimate overseas demand to be sufficient to support the
necessary sales. Furthermore, if demand is sufficient and overseas expansion occurs, Electcomp is likely to raise its prices.
Using O to represent the event of overseas expansion, I to represent a price increase, and I C to represent
no price increase, an industry analyst has estimated the unconditional and conditional probabilities shown
as follows:
Multiplication rule:
P(O | I) = P(IO) / P(I), and P(IO) = P(I | O) × P(O)
To get BF, substitute the 2nd equation into the first [for P(IO)] and solve for P(I | O)}:
