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QUANTITATIVE-ME THODS

The p-value in Hypothesis Testing

27 Aug 2019

The p-value is the lowest level of signiScance at

which we can reject a null hypothesis. It is the
probability of coming up with a test statistic that
would justify our rejection of a null hypothesis,
assuming that the null hypothesis is indeed true.

Breaking Down the p-value

When carrying out a statistical test with a Sxed value
of the signiScance level (α), we merely compare the
observed test statistic with some critical value. For
example, we might “reject a H0 using a 5% test” or
“reject a H0 at 1% signiScance level.” The problem
with this ‘classical’ approach is that it does not give
us the details about the strength of the evidence
against the null hypothesis.

Determination of the p-value gives statisticians a

more informative approach to hypothesis testing. The
p-value is actually the lowest level at which we can
reject a H0. This means that the strength of the
evidence against a H0 increases as the p-value
becomes smaller.

For one-tailed tests, the p-value is given by the

probability that lies below the calculated test statistic
for left-tailed tests. In the case of right-tailed tests,
the probability that lies above the test statistic gives
the p-value. However, if the test is two-tailed, this
value is given by the sum of the probabilities in the
two tails. We start by determining the probability
lying below the negative value of the test statistic.
After this, we add this to the probability lying above
the positive value of the test statistic.

Example: p-value
θ represents the probability of obtaining a head when
a coin is tossed. Assume that we tossed a coin 200
times and the head came up in 85 out of of the 200
trials. Test the following hypothesis at a 5% level of
signiScance.

H0: θ = 0.5

H1: θ < 0.5

Solution

First, note that repeatedly tossing a coin follows a

binomial distribution.

Our p-value will be given by P(X < 85) where X

follows a binomial (200,0.5), assuming the H0 is true.

= P [Z < ]
(85.5– 100)
√50
= P (Z < −2.05) = 1– 0.97982 = 0.02018

(We have applied the Central Limit Theorem by

taking the binomial distribution as approximately
normal.)

Since the probability is less than 0.05, the H0 is

extremely unlikely, and we actually have strong
evidence against a H0 that favors H1. Therefore,
clearly expressing this result, we could say:

“There is very strong evidence against the hypothesis

that the coin is fair. We, therefore, conclude that the
coin is biased against heads.”

Remember, failure to reject a H0 does not mean it is

true. It means there is insufScient evidence to justify
the rejection of the H0 given a certain level of
signiScance.

Question

A CFA candidate conducts a statistical test

about the mean value of a random variable X.

H0: μ = μ0 vs H1: μ ≠ μ0

She obtains a test statistic of 2.2. Given a 5%

signiKcance level, determine the p-value.

A. 1.39%.

B. 2.78.

C. 2.78%.

Solution

The correct answer is C.

P − value = P (Z > 2.2) = 1– P (Z < 2.2) = 1.39

(We have multiplied by two since this is a two-

tailed test.)

Interpretation: The p-value (2.78%) is less than

the level of signiKcance (5%). Therefore, we have
sufKcient evidence to reject the H0. In fact, the
evidence is so strong that we would also reject
the H0 at signiKcance levels of 4% and 3%.
However, at signiKcance levels of 2% or 1%, we
would not reject the H0 since the p-value
surpasses these values.

Hypothesis Testing (2023 Level I…

The p-value is the lowest level of signiScance at

which we can reject a null hypothesis. It is the
probability of coming up with a test statistic that
would justify our rejection of a null hypothesis,
assuming that the null hypothesis is indeed true.

Breaking Down the p-value

When carrying out a statistical test with a Sxed value
of the signiScance level (α), we merely compare the
observed test statistic with some critical value. For
example, we might “reject a H0 using a 5% test” or
“reject a H0 at 1% signiScance level.” The problem
with this ‘classical’ approach is that it does not give
us the details about the strength of the evidence
against the null hypothesis.

Determination of the p-value gives statisticians a

more informative approach to hypothesis testing. The
p-value is actually the lowest level at which we can
reject a H0. This means that the strength of the
evidence against a H0 increases as the p-value
becomes smaller.

For one-tailed tests, the p-value is given by the

probability that lies below the calculated test statistic
for left-tailed tests. In the case of right-tailed tests,
the probability that lies above the test statistic gives
the p-value. However, if the test is two-tailed, this
value is given by the sum of the probabilities in the
two tails. We start by determining the probability
lying below the negative value of the test statistic.
After this, we add this to the probability lying above
the positive value of the test statistic.

Example: p-value
θ represents the probability of obtaining a head when
a coin is tossed. Assume that we tossed a coin 200
times and the head came up in 85 out of of the 200
trials. Test the following hypothesis at a 5% level of
signiScance.

H0: θ = 0.5

H1: θ < 0.5

Solution

First, note that repeatedly tossing a coin follows a

binomial distribution.

Our p-value will be given by P(X < 85) where X

follows a binomial (200,0.5), assuming the H0 is true.

= P [Z < ]
(85.5– 100)
√50
= P (Z < −2.05) = 1– 0.97982 = 0.02018

(We have applied the Central Limit Theorem by

taking the binomial distribution as approximately
normal.)

Since the probability is less than 0.05, the H0 is

extremely unlikely, and we actually have strong
evidence against a H0 that favors H1. Therefore,
clearly expressing this result, we could say:

“There is very strong evidence against the hypothesis

that the coin is fair. We, therefore, conclude that the
coin is biased against heads.”

Remember, failure to reject a H0 does not mean it is

true. It means there is insufScient evidence to justify
the rejection of the H0 given a certain level of
signiScance.

Question

A CFA candidate conducts a statistical test

about the mean value of a random variable X.

H0: μ = μ0 vs H1: μ ≠ μ0

She obtains a test statistic of 2.2. Given a 5%

signiKcance level, determine the p-value.

A. 1.39%.

B. 2.78.

C. 2.78%.

Solution

The correct answer is C.

P − value = P (Z > 2.2) = 1– P (Z < 2.2) = 1.39

(We have multiplied by two since this is a two-

tailed test.)

Interpretation: The p-value (2.78%) is less than

the level of signiKcance (5%). Therefore, we have
sufKcient evidence to reject the H0. In fact, the
evidence is so strong that we would also reject
the H0 at signiKcance levels of 4% and 3%.
However, at signiKcance levels of 2% or 1%, we
would not reject the H0 since the p-value
surpasses these values.

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