Prior Probability

DEFINITION of 'Prior Probability'

The probability that an event will reflect established beliefs about the event before the arrival of new evidence or information. Prior probabilities are the original probabilities of an outcome, which be will updated with new information to create posterior probabilities.

BREAKING DOWN 'Prior Probability'

Prior probabilities represent what we originally believed before new evidence is uncovered. New information is used to produce updated probabilities and is a more accurate measure of a potential outcome. For example, three acres of land have the labels A, B and C. One acre has reserves of oil below its surface, while the other two do not. The probability of oil being on acre C is one third, or 0.333. A drilling test is conducted on acre B, and the results indicate that no oil is present at the location. Since acres A and C are the only candidates for oil reserves, the prior probability of 0.333 becomes 0.5, as each acre has one out of two chances.

RELATED TERMS
  1. Bayes' Theorem

    A formula for determining conditional probability named after ...
  2. Posterior Probability

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

    A statistical function that describes all the possible values ...
  4. Unconditional Probability

    The probability that an event will occur, not contingent on any ...
  5. Value At Risk - VaR

    A statistical technique used to measure and quantify the level ...
  6. A Priori Probability

    Probability calculated by logically examining existing information. ...
Related Articles
  1. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  2. Markets

    The Uses And Limits Of Volatility

    Check out how the assumptions of theoretical risk models compare to actual market performance.
  3. Fundamental Analysis

    Find The Right Fit With Probability Distributions

    Discover a few of the most popular probability distributions and how to calculate them.
  4. Bonds & Fixed Income

    Find The Highest Returns With The Sharpe Ratio

    Learn how to follow the efficient frontier to increase your chances of successful investing.
  5. Active Trading Fundamentals

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  6. Active Trading Fundamentals

    How To Convert Value At Risk To Different Time Periods

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  7. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  8. 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.
  9. Markets

    The (Expected) Market Impact of the 2016 Election

    With primary season upon us, investor attention is beginning to turn to the upcoming U.S. presidential election.
  10. Term

    How Statistical Significance is Determined

    If something is statistically significant, it’s unlikely that it happened by chance.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. What types of assets lower portfolio variance?

    Assets that have a negative correlation with each other reduce portfolio variance. Variance is one measure of the volatility ... Read Full Answer >>
  6. 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 >>
Hot Definitions
  1. Black Swan

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

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

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. 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 ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center