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."
Investopedia explains '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.