Bayes' Theorem

DEFINITION of 'Bayes' Theorem'

A formula for determining conditional probability named after 18th-century British mathematician Thomas Bayes. The theorem provides a way to revise existing predictions or theories given new or additional evidence. In finance, Bayes' Theorem can be used to rate the risk of lending money to potential borrowers.

The formula is as follows:




Also called "Bayes' Rule."

BREAKING DOWN 'Bayes' Theorem'

Applications of the theorem are widespread and not limited to the financial realm. As an example, Bayes' Theorem can be used to determine the accuracy of medical test results by taking into consideration how likely any given person is to have a disease and the general accuracy of the test.

RELATED TERMS
  1. Financial Modeling

    The process by which a firm constructs a financial representation ...
  2. Posterior Probability

    The revised probability of an event occurring after taking into ...
  3. Risk

    The chance that an investment's actual return will be different ...
  4. Prior Probability

    The probability that an event will reflect established beliefs ...
  5. Conditional Probability

    Probability of an event or outcome based on the occurrence of ...
  6. Tight Monetary Policy

    A course of action undertaken by the Federal Reserve to constrict ...
Related Articles
  1. Investing Basics

    Regression Basics For Business Analysis

    This tool is easy to use and can provide valuable information on financial analysis and forecasting. Find out how.
  2. Fundamental Analysis

    Find The Right Fit With Probability Distributions

    Discover a few of the most popular probability distributions and how to calculate them.
  3. Active Trading Fundamentals

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  4. Forex Education

    Financial Forecasting: The Bayesian Method

    This method can help refine probability estimates using an intuitive process.
  5. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
  6. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  7. Economics

    The Truth about Productivity

    Why has labor market productivity slowed sharply around the world in recent years? One of the greatest economic mysteries out there.
  8. Term

    How Market Segments Work

    A market segment is a group of people who share similar qualities.
  9. Active Trading

    Market Efficiency Basics

    Market efficiency theory states that a stock’s price will fully reflect all available and relevant information at any given time.
  10. Fundamental Analysis

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
RELATED FAQS
  1. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  2. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  3. Do plane tickets get cheaper closer to the date of departure?

    The price of flights usually increases one month prior to the date of departure. Flights are usually cheapest between three ... Read Full Answer >>
  4. Is Colombia an emerging market economy?

    Colombia meets the criteria of an emerging market economy. The South American country has a much lower gross domestic product, ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center