Prior Probability

AAA

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.

INVESTOPEDIA EXPLAINS '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. A Priori Probability

    Probability calculated by logically examining existing information. ...
  6. Value At Risk - VaR

    A statistical technique used to measure and quantify the level ...
Related Articles
  1. Markets

    The Uses And Limits Of Volatility

    Check out how the assumptions of theoretical risk models compare to actual market performance.
  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. 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.
  4. Active Trading Fundamentals

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  5. 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".
  6. 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".
  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. Fundamental Analysis

    What is a Null Hypothesis?

    In statistics, a null hypothesis is assumed true until proven otherwise.
  9. Investing

    How to Use Stratified Random Sampling

    Stratified random sampling is a technique best used with a sample population easily broken into distinct subgroups. Samples are then taken from each subgroup based on the ratio of the subgroup’s ...
  10. Fundamental Analysis

    Lognormal and Normal Distribution

    When and why do you use lognormal distribution or normal distribution for analyzing securities? Lognormal for stocks, normal for portfolio returns.

You May Also Like

Hot Definitions
  1. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  2. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  3. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  4. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  5. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  6. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
Trading Center