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Population Mean
i=1
N
n
Sample Mean
X=
i=1
n
N
Population Variance
2=
Xi
i=1
X
n
Sample Variance
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S2 =
i=1
n-1
X N ( ,
)
n
x / n
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Point Estimation
Level of significance ()
Degree of Confidence (1 )
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X z 2
X 1.96
X 1.96
95%
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AnswerB
The confidence interval for the interest rate coefficient is:
[1.50-1.960.20,1.50+1.960.20]= [1.11, 1.89]
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Example
The 95% confidence interval of the sample mean of employee age for a major
corporation is 19 years to 44 years based on a z-statistic. The population of
employees is more than 5,000 and the sample size of this test is 100. Assuming
the population is normally distributed, the standard error of mean employee age
is closest to:
A. 1.96.
B. 2.58.
C. 6.38.
D. 12.50.
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X t 2
X 2
s
n
X 2
95%
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Hypothesis Testing
One-tailed test
H0: 0
Ha: <0
H0: 0
Ha: >0
Two-tailed test
H0: =0
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Ha: 0
FRMFinancial Risk Manager
Test statistic
sample statistic - hypothesized value
test statistic =
standard error of the sample statistic
Critical value
Significance level ()
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Decision Rule
2.5%
95%
-1.96
Reject H0
1.96
Fail to
Reject H0
5%
95%
1.645
Reject H0
Fail to
Reject H0
Reject H0
P value testing
2.5%
2.5%
1.07%
1.07%
Negative of the
test statistic
Positive of the
test statistic
P - value=2.14%
If Pvalue < alpha, we reject null hypothesis
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H0: =0
z-test vs. t-test
Normal population, n<30
n30
z-test
z-test
t-test
t-test or z-test
z-statistic Z x 0
/ n
t-statistic t n 1
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x 0
s/ n
H0: =0
The chi-square test (-test)
(n 1) s 2
2
0
df=n-1
n=sample size
s2=sample variance
02=hypothesized value for the population variance
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H0: 1=2
The F-test
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F 2
s2
df1=n1-1; df2=n2-1
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Test type
Assumptions
H0
Test-statistic
=0
Mean
hypothesis
testing Normally distributed population,
unknown population variance
Normally distributed population
Variance
hypothesis
testing Two independent normally
distributed populations
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=0
=0
1=2
x 0
/ n
x 0
N(0,1)
t(n-1)
s/ n
Critical value
(n 1) s 2
2
s
1
F
2
0
s 22
2 (n 1)
F (n1 1, n2 1)
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72. An analyst believes that the average return of hedge funds was12% over the past year.
The analyst picks a random sample of 10 hedge funds and finds that their average return
was 29% with a standard of 24% over the past year. The analyst decides to test at a 95%
confidence level the null hypothesis H0: the average return of hedge funds was 12%. The
possible related critical values of the t-statistic are provided below:
H0: =12%
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Ha: 12%
x 0
29% 12%
tn1
2.2399 2.262
s / n 24% / 10
Type II error: fail to reject the null hypothesis when its actually false
Significance level (): the probability of making a Type I error
Significance level =P (Type I error)
Power of a test: the probability of correctly rejecting the null hypothesis when it is false
Power of a test = 1P(Type II error)
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Chebyshevs Inequality
k
1 - 1/kk>1
P(|X-| k) 1 - 1/k
k>1
1
1 3
1 2 1 75%
4 4
2
1
1 8
At
1 2 1 89%
9 9
least
3
1
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1
1 15
94%
2
16 16
4
Lie
within
3
4
Standard
deviations
of the mean
Example
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FRM
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