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## Empirical, Subjective and Priori Probability

There are three types of probabilities: Empirical Probability Based on observed or historical data. Subjective Probability Based on an individual’s judgement about the probability of occurrence of an event. The probability of an event is determined by an individual,...

## Two Defining Properties of Probability

There are two important properties of probability. The probability of an event E is between 1 and 0, i.e., 0 < P(E) < 1. The sum of probabilities of all mutually exclusive and exhaustive events is equal to 1. These two properties together define probability....

## Probability – Basic Terminology

Before we learn about the probability concepts, it is important to know the basic terminology. Random Variable A random variable is one of the most important concepts in finance. A random variable is a variable whose value is an outcome of a random phenomenon, for...

## Sharpe Ratio

While deciding about what investments to make, one should weigh the rewards versus the risks of the investment opportunity. The Sharpe ratio is one popular measure of return on risk. It is named after Nobel Laureate professor William F. Sharpe. The Sharpe ratio...

## Coefficient of Variation

We earlier learned about calculating the variance and standard deviation for a set of data. Standard deviation as a measure of dispersion is much easier to interpret as it uses the same unit of measurement as the data itself. However, standard deviation is not a good...

## Chebyshev’s Inequality

Chebyshev’s Inequality is used to describe the percentage of values in a distribution within an interval centered at the mean. It states that for a distribution, the percentage of observations that lie within k standard deviations is atleast 1 – 1/k2 This is...

## Variance and Standard Deviation

Risk is the possibility that actual returns might differ, or vary, from expected returns. In fact, actual returns will most likely differ from expected returns. It is important for decision-makers to estimate the magnitude and likelihood of the difference between...