Bayesian updating formula
Lawsuits, changes in the prices of raw materials, and many other things can heavily influence the value of a company's net income.
By using probability estimates relating to these factors, we can apply Bayes' Theorem to figure out what is important to us.
(See to read about the effects of a bad forecast.) Now that we have learned how to correctly compute Bayes' Theorem, we can now learn just where it can be applied in financial modeling.
Other, and much more inherently complicated business specific, full-scale examples will not be provided, but situations of where and how to use Bayes' Theorem will.
This is the prior probability based on historical data, which in this example is 57.5% (1150/2000).
This probability doesn't take into account any information about interest rates, and is the one we wish to update.
Changing interest rates can heavily affect the value of particular assets.
This is because it has occurred after original event, hence the post in posterior.This is how Bayes' theorem uniquely allows us to update our previous beliefs with new information.The example below will help you see how it works while incorporating it within an equity market concept.We'll deem this event event A, and its probability P(A).If there is a second event that affects P(A), which we'll call event B, then we want to know what the probability of A is given B has occurred.