What Is Subjective Probability?
Subjective probability is a type of probability derived from an individual's personal judgment or own experience about whether a specific outcome is likely to occur. It contains no formal calculations and only reflects the subject's opinions and past experience. Subjective probabilities differ from person to person and contain a high degree of personal bias. An example of subjective probability is a 'gut instinct' when making a trade.
Subjective probability can be contrasted with objective probability, which is the computed probability that an event will occur based on an analysis in which each measure is based on a recorded observation or a long history of collected data.
[Important: subjective probabilities are the foundation for common errors and biases observed in the market that stem from 'old wives' tales' or 'rules of thumb'.]
How Subjective Probability Works
The probability of an event is based on the likelihood of that event occurring. In most forms of probability, quantitative information is gathered and interpreted to help determine this likelihood through a mathematical mechanism, normally relating to the mathematical field of statistics. The percentage chance of a flipped coin landing on heads or tails can be interpreted as a probability, expressed as a 50% chance that it will land heads up, and a 50% chance it will land tails up.
Subjective probability, on the other hand, is highly flexible, even in terms of one individual’s belief. While an individual may believe the chance of a specified event occurring is 25%, they could have a different belief when given a specific range from which to choose, such as 25% to 30%. This can occur even if no additional hard data is behind the change.
Subjective probability can be affected by a variety of personal beliefs held by an individual. These could relate back to upbringing as well as other events the person has witnessed throughout his life. Even if the individual’s belief can be rationally explained, it does not make the prediction an actual fact. It is often based on how each individual interprets the information presented to him.
- Subjective probability is a type of probability derived from an individual's personal judgment or own experience about whether a specific outcome is likely to occur.
- It contains no formal calculations and only reflects the subject's opinions and past experience rather than on data or computation.
- Subjective probabilities differ from person to person and contain a high degree of personal bias.
Examples of Subjective Probability
An example of subjective probability is asking New York Yankees fans, before the baseball season starts, about the chances of New York winning the World Series. While there is no absolute mathematical proof behind the answer to the example, fans might still reply in actual percentage terms, such as the Yankees having a 25% chance of winning the World Series.
In another scenario, consider a person who is asked to predict the percentage chance of whether a flipped coin will land with heads or tails up, his initial response may be the mathematically true 50%. If 10 coin flips occur, all resulting in the coin landing tails up, the person may change his percentage chance to a number other than 50%, such as saying the chance of it landing tails up is 75%. Even knowing that the new prediction is mathematically inaccurate, the individual’s personal experience of the previous 10 coin flips has created a situation in which he chooses to use subjective probability.