Financial Risk Manager Part 1
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Suppose you conducted a hypothesis test. What would happen if you decrease the level of significance of the test?
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A
The likelihood of committing a type II error decreases
B
The likelihood of a type I error increases
C
The likelihood of rejecting the null hypothesis when it's in fact true decreases
D
The likelihood of frequently committing a type I error increases, even when it's in fact true
Explanation:
Explanation
When conducting a hypothesis test, the level of significance (denoted by α) represents the probability of rejecting the null hypothesis when it is actually true. Therefore, decreasing the level of significance would decrease the likelihood of rejecting the null hypothesis when it is actually true, reducing the probability of committing a type I error.
Option A is incorrect. The likelihood of committing a type II error (failing to reject a false null hypothesis) is not directly affected by the level of significance. However, decreasing the level of significance may increase the probability of committing a type II error, as it reduces the power of the test to detect a true alternative hypothesis.
Option B is incorrect. Decreasing the level of significance would decrease the probability of committing a type I error (rejecting a true null hypothesis), not increase it.
Option D is incorrect. The likelihood of frequently committing a type I error is not directly related to the level of significance. However, decreasing the level of significance may increase the probability of committing a type I error, as it reduces the threshold for rejecting the null hypothesis.
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