Financial Risk Manager Part 1
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A manager conducts a hypothesis test at the 1% significance level. What does this mean?
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NNikitesh
A
P(reject H₀ | H₀ is false) = 0.01
B
P(reject H₀ | H₀ is true) = 0.01
C
P(not reject H₀ | H₀ is false) = 0.01
D
P(not reject H₀ | H₀ is true) = 0.01
Explanation:
The significance level (α) represents the probability of committing a Type I error, which is rejecting the null hypothesis (H₀) when it is actually true. Therefore, at the 1% significance level, P(reject H₀ | H₀ is true) = 0.01.
Key Concepts:
- Type I Error: Rejecting H₀ when it is true (false positive)
- Type II Error: Failing to reject H₀ when it is false (false negative)
- Significance level (α): Probability of Type I error
- Power (1-β): Probability of correctly rejecting H₀ when it is false
Option A represents the power of the test (1 - Type II error rate). Option C represents the probability of Type II error (β). Option D represents the confidence level (1 - α).
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