Subjective Method Events and Their Probabilities

 Example: Bradley Investments

An event is a collection of sample points.
An analyst made the following probability estimates.

Exper. Outcome Net Gain or Loss Probability The probability of any event is equal to the sum of
(10, 8) $18,000 Gain .20 the probabilities of the sample points in the event.
(10, -2) $8,000 Gain .08
(5, 8) If we can identify all the sample points of an
$13,000 Gain .16
experiment and assign a probability to each, we
(5, -2) $3,000 Gain .26 can compute the probability of an event.
(0, 8) $8,000 Gain .10
(0, -2) $2,000 Loss .12
(-20, 8) $12,000 Loss .02
(-20, -2) $22,000 Loss .06

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Subjective Method Events and Their Probabilities

 Example: Bradley Investments  Example: Bradley Investments

Markley Oil Collins Mining Experimental
(Stage 1) (Stage 2) Outcomes Event M = Markley Oil Profitable
Gain 8 (10, 8) Gain $18,000 M = {(10, 8), (10, -2), (5, 8), (5, -2)}
(10, -2) Gain $8,000 P(M) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2)
Lose 2
Gain 10
Gain 8 (5, 8) Gain $13,000
= .20 + .08 + .16 + .26
= .70
Lose 2 (5, -2) Gain $3,000
Gain 5
Gain 8
(0, 8) Gain $8,000
Even
(0, -2) Lose $2,000
Lose 20 Lose 2
Gain 8 (-20, 8) Lose $12,000
Lose 2 (-20, -2) Lose $22,000

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Events and Their Probabilities Some Basic Relationships of Probability

 Example: Bradley Investments There are some basic probability relationships that
can be used to compute the probability of an event
Event C = Collins Mining Profitable without knowledge of all the sample point probabilities.
C = {(10, 8), (5, 8), (0, 8), (-20, 8)}
P(C) = P(10, 8) + P(5, 8) + P(0, 8) + P(-20, 8) Complement of an Event
= .20 + .16 + .10 + .02
= .48 Union of Two Events

Intersection of Two Events

Mutually Exclusive Events

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1
 Complement of an Event Union of Two Events

The complement of event A is defined to be the event The union of events A and B is the event containing
consisting of all sample points that are not in A. all sample points that are in A or B or both.

The complement of A is denoted by Ac. The union of events A and B is denoted by A B

Sample Sample
Event A Ac Space S Event A Event B Space S

Venn
Diagram

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Union of Two Events Intersection of Two Events

 Example: Bradley Investments

The intersection of events A and B is the set of all
Event M = Markley Oil Profitable sample points that are in both A and B.
Event C = Collins Mining Profitable
The intersection of events A and B is denoted by A 
M C = Markley Oil Profitable
or Collins Mining Profitable (or both)
M C = {(10, 8), (10, -2), (5, 8), (5, -2), (0, 8), (-20, 8)} Sample
P(M C) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2) Event A Event B Space S
+ P(0, 8) + P(-20, 8)
= .20 + .08 + .16 + .26 + .10 + .02
= .82 Intersection of A and B

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Intersection of Two Events Addition Law

 Example: Bradley Investments

The addition law provides a way to compute the
Event M = Markley Oil Profitable probability of event A, or B, or both A and B occurring.
Event C = Collins Mining Profitable
The law is written as:
M C = Markley Oil Profitable
and Collins Mining Profitable P(A B) = P(A) + P(B) - P(A  B
M C = {(10, 8), (5, 8)}
P(M C) = P(10, 8) + P(5, 8)
= .20 + .16
= .36

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2
 Addition Law Mutually Exclusive Events

 Example: Bradley Investments

Two events are said to be mutually exclusive if the
Event M = Markley Oil Profitable events have no sample points in common.
Event C = Collins Mining Profitable
Two events are mutually exclusive if, when one event
M C = Markley Oil Profitable
occurs, the other cannot occur.
or Collins Mining Profitable
We know: P(M) = .70, P(C) = .48, P(M C) = .36
Thus: P(M  C) = P(M) + P(C) - P(M  C) Sample
= .70 + .48 - .36 Event A Event B Space S
= .82
(This result is the same as that obtained earlier
using the definition of the probability of an event.)

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Mutually Exclusive Events Conditional Probability

If events A and B are mutually exclusive, P(A  B = 0.
The addition law for mutually exclusive events is:
P(A B) = P(A) + P(B)
The probability of an event given that another event
has occurred is called a conditional probability.
The conditional probability of A given B is denoted
by P(A|B).

A conditional probability is computed as follows :

There is no need to P( A  B)
P( A|B) 
include “- P(A  B” P( B)

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Conditional Probability Question:

 Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
P(C | M ) = Collins Mining Profitable
given Markley Oil Profitable
We know: P(M C) = .36, P(M) = .70
P(C  M ) .36
Thus: P(C | M )    .5143
P( M ) .70
A bag contains 15 items discovered
from China which are extremely
valuable as items are 10th century
Chinese artifacts. From X-ray
diffraction analysis, it is found that
any 4 are defective. The items are
drawn very carefully and
examined. The ones examined are
not put back. What is the
probability that 10th one examined
is the last defective?

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3
 Multiplication Law Multiplication Law

 Example: Bradley Investments

The multiplication law provides a way to compute the
probability of the intersection of two events. Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
The law is written as: M C = Markley Oil Profitable
and Collins Mining Profitable
P(A B) = P(B)P(A|B)
We know: P(M) = .70, P(C|M) = .5143
Thus: P(M  C) = P(M)P(M|C)
= (.70)(.5143)
= .36
(This result is the same as that obtained earlier
using the definition of the probability of an event.)

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Joint Probability Table Independent Events

Collins Mining If the probability of event A is not changed by the

Markley Oil Profitable (C) Not Profitable (Cc) Total existence of event B, we would say that events A
and B are independent.
Profitable (M) .36 .34 .70
Not Profitable (Mc) .12 .18 .30 Two events A and B are independent if:

Total .48 .52 1.00 P(A|B) = P(A) or P(B|A) = P(B)

Joint Probabilities
(appear in the body
Marginal Probabilities
of the table)
(appear in the margins
of the table)

47 48

Multiplication Law Multiplication Law

for Independent Events for Independent Events
 Example: Bradley Investments
The multiplication law also can be used as a test to see
if two events are independent. Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
The law is written as:
Are events M and C independent?
P(A B) = P(A)P(B) DoesP(M  C) = P(M)P(C) ?
We know: P(M  C) = .36, P(M) = .70, P(C) = .48
But: P(M)P(C) = (.70)(.48) = .34, not .36
Hence: M and C are not independent.

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4
 Example
 Why are some mutual fund managers more
successful than others? One possible factor is where
the manager earned his or her MBA. The following
table compares mutual fund performance against
the ranking of the school where the fund manager
earned their MBA:
Mutual fund outperforms Mutual fund doesn’t
the market outperform the market
Top 20 MBA program .11 .29
Not top 20 MBA program .06 .54


E.g. This is the probability that a mutual fund

outperforms AND the manager was in a top-
20 MBA program; it’s a joint probability
[intersection].
This Photo by Unknown Author is licensed under CC BY-NC-ND

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Conditional Probability… Union can also be found from joint prob.table

What’s the probability that a fund will outperform

  Determine the probability that a fund outperforms (B1)
the market given that the manager graduated from a  or the manager graduated from a top-20 MBA program (A1).
top-20 MBA program? A1 or B1 occurs whenever:
Recall: Define the events A1 and B1 occurs, A1 and B2 occurs, or A2 and B1 occurs…
• A1 = Fund manager graduated from a top-20 MBA
program B1 B2 P(Ai)
• A2 = Fund manager did not graduate from a top- A1 .11 .29 .40
20 MBA program
A2 .06 .54 .60
• B1 = Fund outperforms the market
P(Bj) .17 .83 1.00
• B2 = Fund does not outperform the market
 Thus, we want to know “P(B1 | A1) ?” P(A1 or B1) = .11 + .06 + .29 = .46

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