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. Posterior Probability

    The revised probability of an event occurring after taking into ...
  2. Gross Acres

    The amount of leased real estate, that a petroleum and/or natural ...
  3. Unconditional Probability

    The probability that an event will occur, not contingent on any ...
  4. Net Acres

    The amount of leased real estate that a petroleum and/or natural ...
  5. Probable Reserves

    After an oil exploration firm conducts a seismic survey of a ...
  6. Accelerated Cost Recovery System ...

    A system of depreciation introduced by the Economic Recovery ...
Related Articles
  1. Forex Education

    Financial Forecasting: The Bayesian Method

    This method can help refine probability estimates using an intuitive process.
  2. Professionals

    Basic Probability Concepts

    CFA Level 1 - Probability Concepts - Basics. Discusses randomness and various types of probabilities.
  3. Professionals

    Joint Probability

    CFA Level 1 - Probability Concepts - Joint Probability
  4. Professionals

    Scenario / What-If Analysis

    We look at some ways that you can evaluate your project.
  5. Fundamental Analysis

    Scenario Analysis Provides Glimpse Of Portfolio Potential

    This statistical method estimates how far a stock might fall in a worst-case scenario.
  6. Professionals

    Common Probability Distributions

    CFA Level 1 - Common Probability Distributions - Basics
  7. Term

    Estimating with Subjective Probability

    Subjective probability is someone’s estimation that an event will occur.
  8. Forex Education

    1. What Is The Probability?

    Learn how to make better options trades with the average monthly range.
  9. Fundamental Analysis

    Explaining Expected Return

    The expected return is a tool used to determine whether or not an investment has a positive or negative average net outcome.
  10. Options & Futures

    Multivariate Models: The Monte Carlo Analysis

    This decision-making tool integrates the idea that every decision has an impact on overall risk.
RELATED FAQS
  1. What is the difference between work in progress and work in process?

    Learn how financial institutions can use Bayesian analysis to model credit default risk, and understand how derivatives have ... Read Answer >>
  2. How does an oil and gas company measure and state their reserves?

    Understand how oil and gas companies estimate possible reserves and how different classifications are used to designate the ... Read Answer >>
  3. What is the difference between proven and probable reserves in the oil and gas sector?

    Learn how those in the oil and gas sector classify oil reserves and the specific differences between proven and probable ... Read Answer >>
  4. How are oil reserves accounted for on an oil company's balance sheet?

    Oil reserves are estimated quantities of crude oil that have a high degree of certainty, usually 90%, of existence and exploitability. ... Read Answer >>
  5. What are risks associated with investing in the oil & gas drilling sector?

    Learn what unique risks are present for investment in the energy industry specifically affecting companies working in oil ... Read Answer >>
  6. What developed countries have the greatest exposure to oil & gas drilling?

    Find out which countries have the largest proven reserves of oil and gas, and learn how the energy landscape has changed ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center