Financial Risk Manager Part 1
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Which of the following is the correct sequence of steps in hypothesis testing?
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NNikitesh
A
State the hypothesis, select the level of significance, compute the test statistic, formulate the decision rule, and make a decision.
B
State the hypothesis, select the level of significance, formulate the decision rule, compute the test statistic, and make a decision.
C
State the hypothesis, formulate the decision rule, select the level of significance, compute the test statistic, and make a decision.
D
Formulate the decision rule, state the hypothesis, select the level of significance, compute the test statistic, and make a decision.
Explanation:
The correct sequence of steps in hypothesis testing is:
- State the hypothesis - Formulate the null hypothesis (H₀) and alternative hypothesis (H₁)
- Select the level of significance - Choose the alpha level (typically 0.05, 0.01, or 0.10) which determines the probability of Type I error
- Formulate the decision rule - Determine the critical value(s) or rejection region based on the significance level and test distribution
- Compute the test statistic - Calculate the test statistic from the sample data
- Make a decision - Compare the test statistic with the critical value or use p-value to decide whether to reject or fail to reject the null hypothesis
Option B correctly follows this logical sequence. The decision rule must be formulated BEFORE computing the test statistic because the decision rule establishes the criteria for making the decision based on the test statistic value.
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