Bayesian Analysis

1-17

FRMFinancial Risk Manager

Bayes Theorem

P(AB)=P(A|B)P(B) =P(B|A)P(A)

P( B | A)
P( A | B)
P( A)
P( B)
Figure 1: Probability Matrix for Bond A and Bond B:

P( A | B)

2-17

P( AB) 4% 1

33.33%
P( B) 12% 3

FRMFinancial Risk Manager

Example: Bayes theorem (1)

3-17

FRMFinancial Risk Manager

Example: Bayes theorem (1)

70%

Outperform

Excellent
30%

20%

Not Outperform

Manager
80%

50%

Outperform

Average
50%

4-17

Not Outperform

FRMFinancial Risk Manager

Example: Bayes theorem (2)

5-17

FRMFinancial Risk Manager

Example: Bayes theorem (2)

70%3

Three year Outperform

Excellent
1-70%3

20%

Not Three year Outperform

Manager
80%

50%3

Three year Outperform

Average

1-50%3

6-17

Not Three year Outperform

FRMFinancial Risk Manager

Example: Bayes theorem (2)

7-17

FRMFinancial Risk Manager

Example: Bayes theorem (2)

8-17

FRMFinancial Risk Manager

Example: Bayes theorem (2)

9-17

FRMFinancial Risk Manager

Example: Bayes theorem (3)

10-17

FRMFinancial Risk Manager

Example: Bayes theorem (3)

70%

Outperform

Excellent
1-70%

40.7%

Not Outperform

Manager outperformed the

market the last three years
59.3%

50%

Outperform

Average

1-50%

11-17

Not Outperform

FRMFinancial Risk Manager

Bayes Theorem With Multiple States

12-17

FRMFinancial Risk Manager

Bayes Theorem With Multiple States

80%

Outperform

Excellent
15%
Outperform
50%

Manager

55%

Average

30%
20%

Outperform

Below Average

13-17

FRMFinancial Risk Manager

Bayes Theorem With Multiple States

14-17

FRMFinancial Risk Manager

Bayes Theorem With Multiple States

15-17

FRMFinancial Risk Manager

Bayes Theorem With Multiple States

16-17

FRMFinancial Risk Manager

FRM

17-17

FRMFinancial Risk Manager