HYPOTHESIS TESTING
The process of making judgments about a large group (population) on the
basis of a small subset of that group (sample) is known as statistical inference.
Hypothesis testing, one of two fields in statistical inference, allows us to objectively
assess the probability that statements about a population are true.
- Because these statements are probabilistic in nature, we can never be certain of their
truth.
- Steps in hypothesis testing
1. Stating the hypotheses.
2. Identifying the appropriate test statistic and its probability distribution.
3. Specifying the significance level.
4. Stating the decision rule.
5. Collecting the data and calculating the test statistic.
6. Making the statistical decision.
7. Making the economic or investment decision.
H0= ?
Ha= ?
2
where
where
or
t-distribution
Standard normal
F-distribution
Chi-square distribution
H0: True
H0: False
Correct decision
Type II error
Type I error
Correct decision*
Reject
Mutually exclusive problems:
Suggested Description
0.10
some evidence
0.05
strong evidence
0.01
Decreased Type I
but
Increased Type II
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When more than one test statistic is available, use the one
with the highest power for the specified level of
significance.
The power of a given test statistic also generally increases
with an increase in sample size.
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The critical value (CV) of the test statistic is the value above (below)
which the null hypothesis is rejected.
- Also known as a rejection point.
- One-tailed tests are indicated with a subscript
- Two-tailed tests are indicated with a subscript /2.
CV
CV
12
14
19
20
21
3.
where
is approximately t-distributed.
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Dividend
Month Payers
Not
Payers
Difference
0.2340
0.2203
0.0137
0.4270
0.1754
0.2516
0.1609
0.1599
0.0010
0.1827
0.4676
0.2849
0.3604
0.1504
0.2100
0.4039
0.3398
0.0641
0.3594
0.1332
0.2262
0.1281
0.0582
0.0699
0.0426
0.1488
0.1914
10
0.0653
0.0035
0.0688
11
0.0867
0.1227
0.2094
12
0.0878
0.1781
0.0903
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Dividend
Payers
Not
Payers
Difference
0.1900
0.1714
0.1792
0.1229
0.0108
0.1760
Average
Std Dev
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NONPARAMETRIC STATISTICS
Tests are said to be parametric when they are concerned with parameters
and their validity depends on a definite set of assumptions.
This definition is particularly true when one of the assumptions deals with the
underlying distributional characteristics of the test statistic.
Nonparametric tests, in contrast, are either not concerned with the value of a
specific parameter, or make minimal assumptions about the population from
which the sample is drawn.
- In particular, no, or few, assumptions are made about the distribution of the
population.
Nonparametric tests are useful when:
1. The data do not meet necessary distributional assumptions.
2. The data are given in ranks.
3. The hypothesis does not address the value of the parameter or
parameters.
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SUMMARY
Hypothesis testing allows us to formulate beliefs about investment attributes
and subject those beliefs to rigorous testing following the scientific method.
- For parametric hypothesis testing, we formulate our beliefs (hypotheses),
collect data, and calculate a value of the investment attribute in which we are
interested (the test statistic) for that set of data (the sample), and then we
compare that with a value determined under assumptions that describe the
underlying population (the critical value). We can then assess the likelihood
that our beliefs are true given the relationship between the test statistic and
the critical value.
- Commonly tested beliefs associated with the expected return and variance of
returns for a given investment or investments can be formulated in this way.
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