Probability

DR KISHOR BHANUSHALI
FACULTY MEMBER
IBS- AHMEDABAD
kishorkisu@rediffmail.com
 Probability means

Chance, Possibility, Probably, Likely

The event is not certain to take place
Uncertainty about the happening of an event in
question
Layman Statistics/Mathematics
- Uncertainty about the - Condition under which
happening of an event sensible statements can be
- Belief made
- Wishful thinking - Application of numerical
methods to compute
numerical values of
probability and expectations
 Origin of probability

Games of chances
Gambling
Tossing
Drawing of cards
 Probability ------------ Statistics

Sample
Interpretation of statistical results
Random variations
Conclusions
Foundation of statistical inferences
 Probability ------- Defined

Likelihood or chance of occurrence of an events

Value lies between zero to one (0 – 1)
Classical probability
Relative frequency theory of probability
Subjective approach to probability
Axiomatic approach to probability
 Classical Probability
Oldest and Simple
Eighteenth century
Origin in games of chance
Assumption of equally likely events
Probability is the ratio of the number of favorable cases
to the total number of equally likely cases
Pr (A) =a/n
Pr (not A) = b/n
a/n + b/n = 1
a + b = n
Real life situation is different- cases are not equally likely
A priori concept
 Relative Frequency Theory of Probability

The probability of an event is defined as the relative

frequency with which event occur in an indefinitely
large number of experiments or trials

Lt a
P ( A) = =
→
Theoreticallynwe ∞ n
can never obtain the probability of
an event as given by the limit
In practice we can only try to have close estimate of
P(A) based on large number of bservations
A Posteriori
 Subjective Approach to Probability

1926 – Frank Ramsey

The subjective probability is defined as the
probability assigned to an event by an individual
based on whatever evidences is available
Belief of an individual making a judgments
Very broad and highly flexible
Useful in business decisions
 Axiomatic Approach to Probability

A.N. Kolmogorov 1933 “ Foundation of Probability”

No precise definition of probability
Probability calculations are based on some
postulates
Finite Space
Probability of an event from 0 to 1
P(s)= 1 , Probability of entire sample space
P (AÜB) = P(A) + P(B)
 Probability ---- Some terms

Two events are said to be mutually exclusive or in

compatible when both cannot happen
simultaneously in a single trial or in other words the
occurrence of any one of the event precludes the
occurrence of the other event. If A and B are
mutually exclusive, that P(AB) = 0
Two events are said to be independent when the
outcome of one event does not affect or is affected by
the outcome of another event
Events are said to be equally likely when one events
does not occur more often than the other.
 Probability ---- Some terms

In the case of simple events we consider the

probability of the happening or not happening of
single events while in the case of compound
events we consider the joint occurrence of two or
more events
Events are said to be exhaustive when their totality
include all the possible outcome of a random
experiments (sample space)
Events A is called complementary event of B is A
and B are mutually exclusive and exhaustive. It is
written as AB
 Additional Theorem

P (A or B) = P (A) + P (B) for mutually exclusive

events (Two events are mutually exclusive if they
cannot occur at the same time) P(A and B) = 0

P (A or B) = P (A) + P (B) – P (A and B) for mutually

non exclusive events (n events which aren't mutually
exclusive, there is some overlap) When P(A) and
P(B) are added, the probability of the intersection
(and) is added twice. To compensate for that double
addition, the intersection needs to be subtracted.
 Additional Theorem

Planned to Actually Purchased

Purchase YES NO Total
YES 200 50 250
NO 100 650 750
TOTAL 300 700 1000
 Multiplication Theorem

If two events A and B are independent, the probability

that both will occur is equal to the product of their
individual probabilities
Prob A and B = Prob A * Prob B (independent events)
 Conditional Probability

When computing the probability of a particular

event A, given information about the occurrence of
event B, this probability is called conditional
probability P(A|B)
The probability of A given B is probability of A and B
divided by the probability of B
P(A|B) = P (A and B)
P(B)
 Bayes’ Theorem

Bayes' Theorem is a theorem of probability theory

originally stated by the Reverend Thomas Bayes
It can be seen as a way of understanding how the
probability that a theory is true is affected by a new
piece of evidence
 Example

 Marie is getting married tomorrow, at an outdoor

ceremony in the desert. In recent years, it has
rained only 5 days each year. Unfortunately, the
weatherman has predicted rain for tomorrow.
When it actually rains, the weatherman correctly
forecasts rain 90% of the time. When it doesn't
rain, he incorrectly forecasts rain 10% of the time.
What is the probability that it will rain on the day
of Marie's wedding?
 Solution
 The sample space is defined by two mutually-exclusive events - it rains or it
does not rain. Additionally, a third event occurs when the weatherman predicts
rain. Notation for these events appears below.
 Event A1. It rains on Marie's wedding.
 Event A2. It does not rain on Marie's wedding
 Event B. The weatherman predicts rain.
 In terms of probabilities, we know the following: P( A1 ) = 5/365 =0.0136985 [It
rains 5 days out of the year.]
 P( A2 ) = 360/365 = 0.9863014 [It does not rain 360 days out of the year.]
 P( B | A1 ) = 0.9 [When it rains, the weatherman predicts rain 90% of the time.]
 P( B | A2 ) = 0.1 [When it does not rain, the weatherman predicts rain 10% of
the time.]
 We want to know P( A1 | B ), the probability it will rain on the day of Marie's
wedding, given a forecast for rain by the weatherman. The answer can be
determined from Bayes' theorem, as shown below.
 P( A1 | B ) =P( A1 ) P( B | A1 )/P( A1 ) P( B | A1 ) + P( A2 ) P( B | A2 )P( A1 | B )
 =(0.014)(0.9) / [ (0.014)(0.9) + (0.986)(0.1) ]P( A1 | B ) =0.111
 Probability Distribution

Frequency distribution is a listing of all the outcomes

of an experiments that actually occurred when the
experiment was done
The probability distribution is a listing of all the
probabilities of all the possible outcomes that could
result if the experiment were done
Discrete probability distribution can take only
limited number of values which can be listed
Under continuous probability distribution variable
can take any value within a given range so that we
cannot list all possible outcome
 Probability Distribution of a Discrete Random Variable

A probability distribution for a discrete random

variable is a mutually exclusive listing of all possible
numerical outcomes for that variable such that a
particular probability of occurrence is associated
with each outcome
Expected value of a random variable
Variance of a random variable
Standard deviation of a random variable
Covariance and its application in finance
 Binomial Distribution

Frequency distribution where only two (mutually

exclusive) outcomes are possible, such as better or
worse, gain or loss, head or tail, rise or
fall, success or failure, yes or no.
Therefore, if the probability of success in any given
trial is known, binomial distributions can
be employed to compute a given number of successes
in a given number of trials.
 Binomial Distribution

n!
−
X n− X
P( X ) =
X !(n − X )!
p (1 p)

P(X) = Probability of X successes, given “n” and “p”

n = number of observations
p = Probability of success
1-p = probability of failure
X = number of success in the sample
 Poisson Distribution

The Poisson distribution is used to describe a

number of processes, including distribution of
telephone calls going through the switchboard
system, the demand of patient for services at a health
institution, the arrivals of trucks and cars at the
tollbooth, and the number of accidents at an
intersection
 Poisson Distribution

P ( X ) =e
−λ
λ x

X!

P(X) = the probability of X events in an area of opportunity

λ= expected number of events
e = mathematical constant approximated by 2.71828
X = number of events
 Continuous Probability Distributions

Continuous probability density function

Normal distribution
Uniform distribution/rectangular distribution
Exponential distribution
 Normal Distribution

Normal distribution is represented by the classical

bell shape
In the normal distribution you can calculate the
probability that various values occur within certain
range or intervals
Exact probability of a particular value from a
continuous distribution such as normal distribution
is zero
 Normal Probability Density Function

1 − (1 / 2 ){( X − µ ) / σ }2
f (X ) = e
2πσ
e = the mathematical constant approximated by 2.71828
π= the mathematical constant approximated by 3.14159
π= the mean
σ= the standard deviation
X = any value of the continuous variable, where - ∞ < X< ∞
 Normal Distribution

Continuous random variable

There is no single normal curve, but the family of
normal curves.
To define a particular normal probability
distribution, we need only two parameters: the mean
and standard deviation
Transformation formula X −µ
Z=
σ