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OPRE 6301/SYSM 6303

Quantitative Introduction to Risk and
Uncertainty in Business
6-1

Chapter Six
Probability

6-2

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Assigning Probability
Random Experiment
An action or process that leads to one of several
possible outcomes

Examples:
Flipping a coin
Measuring time to walk to class
Recording a persons favorite color
6-6

Assigning Probability
Sample Space
A list of all possible outcomes of a random
experiment where the outcomes are exhaustive
and mutually exclusive

S O1 , O2 ,, Ok

6-8

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Assigning Probability
Requirements of Probabilities

0 P Oi 1
k

PO 1
i 1

6-11

Assigning Probability
Three Approaches
Classical
Relative Frequency
Subjective

6-12

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Assigning Probability
Classical Probability Theory
Assign probabilities based on the premise of all
outcomes being equally likely to occur
Experiment: Rolling a die
Outcomes: { 1, 2, 3, 4, 5, 6 }
Probabilities: Each sample point has a 1/6
chance of occurring
6-14

Assigning Probability
Classical Probability Theory
Experiment: Rolling two dice and observing the
total
Outcomes: { 2, 3, , 12 }
Example:

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Assigning Probability
Relative Frequency Probability Theory
Assign probabilities based on experimentation or
historical data with respect to the frequency with
which the outcomes occur(ed)

6-20

Assigning Probability
Subjective Probability Theory
Assign probabilities based on the assignors
(subjective) judgment

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Assigning Probability
Simple Event
An individual outcome of a sample space

Event
A collection or set of one or more simple events in
a sample space

6-23

Assigning Probability
Probability of an event
The sum of the probabilities of the simple events
that constitute the event

P A 0.25; P B 0.35; P C 0.30; P F 0.10

P passing the course P A P B P C
0.25 0.35 0.30
0.90
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Joint Probability
The intersection of events A and B
is the event that occurs when
both A and B occur.
It is denoted A and B
The probability of the intersection is called
the joint probability
6-29

Joint Probability

A1 = Fund manager graduated from

a top-20 MBA program
A2 = Fund manager did not graduate from
a top-20 MBA program
B1 = Fund outperforms the market
B2 = Fund does not outperform the market
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Joint Probability

P A1 and B1 0.11

P A2 and B1 0.06

P A1 and B2 0.29

P A2 and B2 0.54
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Marginal Probability
The probability of an event
without regard to other events
having occurred
is called a marginal probability

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Conditional Probability
The probability of event A given event B
has occurred is

P A B

P A and B
P B

6-39

Conditional Probability
We randomly select a mutual fund and
discover it did not outperform the market.
What is the probability that a graduate of a
top-20 MBA program manages it?

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Conditional Probability
We randomly select a mutual fund and
discover it did not outperform the market.
What is the probability that a graduate of a
top-20 MBA program manages it?

P A1 B2

P A1 and B2 .29

.349
P B2
.83
6-41

Independence
Two events A and B are said to be
independent if

P A B P A
or

P B A P B

6-42

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Independence
Is a fund being managed by a top-20 MBA
manager independent of whether it
outperforms the market?
P A1 B1 P A1 ?

P A1 B1

P A1 and B1 .11

.647
P B1
.17

P A1 .40

The two events are not independent.

6-47

Union
The union of two events A and B is the
event that occurs when either A or B or
both occur
It is denoted A or B

B
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Union
What is the probability of a randomly
selected fund being managed by a
graduate of a top-20 MBA program or
outperforming the market?
P A1 or B1 P A1 and B1 P A2 and B1 P A1 and B2
.11 .06 .29 .46

6-50

Complement Rule
The complement of event A is the event
that occurs when event A does not
It is denoted Ac
P Ac 1 P A

Ac
6-53

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Mutually Exclusivity
Two events that cannot occur at the same time
are referred to as mutually exclusive

6-55

Multiplication Rule
Calculates the joint probability of two
events
P A and B P B P A B

or

P A and B P AP B A

For independent events:

P A and B P AP B
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Class: 7 men and 3 women

What is the probability of two students
chosen at random both being women?

6-59

Class: 7 men and 3 women

A student is chosen at random in two
subsequent class sessions. What is the
probability the chosen student in both class
sessions is a woman?

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Addition Rule
Calculates the probability of the union of
two events
P A or B P A P B P A and B

6-61

Newspaper
The Sun: 22%; The Post: 35%; Both: 6%
What portion of the city subscribe to either
newspaper?

6-62

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Probability Trees
Class: 7 men and 3 women
Two students chosen at the same time.

6-63

Probability Trees
Class: 7 men and 3 women
A student chosen in two subsequent class sessions

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