Bayes' Theorem

AAA

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.

RELATED TERMS
  1. Posterior Probability

    The revised probability of an event occurring after taking into ...
  2. Financial Modeling

    The process by which a firm constructs a financial representation ...
  3. Conditional Probability

    Probability of an event or outcome based on the occurrence of ...
  4. Prior Probability

    The probability that an event will reflect established beliefs ...
  5. Risk

    The chance that an investment's actual return will be different ...
  6. Financial Singlularity

    A financial singularity is the point at which investment decisions ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. What are some of the more common types of regressions investors can use?

    The most common types of regression an investor can use are linear regressions and multiple linear regressions. Regressions ... Read Full Answer >>
  4. What types of assets produce negative portfolio variance?

    Assets that have a negative correlation with each other produce negative portfolio variance. Variance is one measure of the ... Read Full Answer >>
  5. When is it better to use systematic over simple random sampling?

    Under simple random sampling, a sample of items is chosen randomly from a population, and each item has an equal probability ... Read Full Answer >>
  6. What are some common financial sampling methods?

    There are two areas in finance where sampling is very important: hypothesis testing and auditing. The type of sampling methods ... Read Full Answer >>
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. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 500 Trust

    Find out more about the SPDR S&P 500 ETF Trust, the characteristics of the exchange traded fund and the suitability of investing in the fund.
  6. Mutual Funds & ETFs

    ETF Analysis: Energy Select Sector SPDR

    Find out more about the Energy Select Sector SPDR Fund, the top holdings of this exchange-traded fund and the characteristics of the fund.
  7. Investing News

    The Financial Singularity Will Destroy Your Return

    Given the current and future growth of financial technology, many believe algorithms will soon define what drives market outcomes. With a wealth of big data, algorithms would be able to create ...
  8. Economics

    Explaining the Liquidity Coverage Ratio

    The liquidity coverage ratio requires banks and other financial institutions to hold enough cash and liquid assets on hand to weather market stress.
  9. Fundamental Analysis

    Calculating Valuation

    Valuation is the process of determining what an asset is worth.
  10. Economics

    Will the Selloff in China Hurt the Global Economy?

    Though China is the world’s second largest economy, its volatility in the stock market is unlikely to have an impact on the global or Chinese economy.

You May Also Like

Hot Definitions
  1. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  2. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  3. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  4. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  5. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  6. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!