oo ooo oOo 8 ooog (©2015 Kaplan, Ine. Tapie 15 ‘Cross Reference to GARP Assigned Reading ~ Miller, Chapter 2 Page 17Topic 15 | Page 18 Cross Reference to GARP Assigned Reading ~ Miller, Chapter 2 Conpiriowar Propaniuries Define and calculate a conditional probability, and distinguish beoween ‘al and unconditional probabilities, As noted earlier, there are ewo defining properties of probability: + The probability of occurrence of any event (B,) is beeween O and 1 (ie. 0 < P(E) < 1). + Ifa ser of events, Ey, Ey... Eyy is mutually exclusive and exhaustive, the probabilities of those events sum t0 1 (i.e., P(E) = 1). ‘The first ofthe defining properties introduces the rerm P(E), which is shorthand for che “probability of event i.” IFP(E,) = 0, the evene will never happen, IFP(E,) = 1, che event is certain to occur, and the outcome is not random. 12 probability of rolling any one of the numbers 1-6 with a fair die is 1/6 ~ 0.1667 ~ 16.7%. The set of events—rolling a number equal to 1, 2, 3, 4, 5, or 6—is exhaustive, and the individual events are mutually exclusive, so the probability of this set of events is equal to 1. We arg certain that one of the values in this set of events will occur. Unconditional probability (ie., marginal probability) refers to the probability of an event regardless of the past or future occurrence of other events. Ifwe are concerned with the probability of an economic recession, regardless of the occurrence of changes in interest rates or inflation, we are concerned with the unconditional probability of a recession, A conditional probability is one where the occurrence of onc event affects the probability of the occurrence of another event. For example, we might be concerned with the probabilicy fe recession given that the monetary authority increases interest raves. This is « conditional probability. The key word to watch for here is “given.” Using probability notation, “the probability of A givey the occurrence of B” is expressed as P(A | B), where the vertical bar ({) indicates “given,” or “conditional upon.” For example, the probability of a recession given an increase in interest rates is expressed as P(recession | increase in interest rates). A conditional probability of an occurrence is also called its likelihood. ‘The joint probability of two events is the probability thar they will both occur. We ‘ean calculate this from the conditional probability that A will occur given B oceuts (a conditional probability) and che probability chat B will occur (the unconditional probability of B). This calculation is sometimes referred to as the multiplication rule of probabiliey Using the notation for conditional and unconditional probabilities, we can express this rule a P(AB) = P(A] B) x P(B) This expression is ead as follows: “The joint probability of A and B, P(AB), is equal ro the conditional probability of A given B, P(A | B), times the unconditional probability of B, ‘P(B).” ‘©2015 Kaplan, Ine.