In statistical hypothesis testing, the p-value or probability value or asymptotic significance is the probability for a given statistical model that, when the null hypothesis is true, the statistical summary would be the same as or of greater magnitude than the actual observed results. The use of p-values in statistical hypothesis testing is common in many fields of research such as physics, economics, finance, political science, psychology, biology, criminal justice, criminology, and sociology. Their misuse has been a matter of considerable controversy.
What is the ‘P-Value’
The p-value is the level of marginal significance within a statistical hypothesis test representing the probability of the occurrence of a given event. The p-value is used as an alternative to rejection points to provide the smallest level of significance at which the null hypothesis would be rejected. A smaller p-value means that there is stronger evidence in favor of the alternative hypothesis.
P-values are calculated using p-value tables or spreadsheet/statistical software. Because different researchers use different levels of significance when examining a question, a reader may sometimes have difficulty comparing results from two different tests. For example, if two studies of returns from two particular assets were undertaken using two different significance levels, a reader could not compare the probability of returns for the two assets easily.
P-Value Approach to Hypothesis Testing
The p-value approach to hypothesis testing uses the calculated probability to determine whether there is evidence to reject the null hypothesis. The null hypothesis, also known as the conjecture, is the initial claim about a population of statistics. The alternative hypothesis states whether the population parameter differs from the value of the population parameter stated in the conjecture. In practice, the p-value, or critical value, is stated in advance to determine how the required value to reject the null hypothesis.
Type I Error
A type I error is the false rejection of the null hypothesis. The probability of a type I error occurring, or rejecting the null hypothesis when it is true, is equivalent to the critical value used. Conversely, the probability of accepting the null hypothesis when it is true is equivalent to 1 minus the critical value.
Assume an investor claims that her investment portfolio’s performance is equivalent to that of the Standard & Poor’s (S&P) 500 Index. The investor conducts a two-tailed test. The null hypothesis states that the portfolio’s returns are equivalent to the S&P 500’s returns over a specified period, while the alternative hypothesis states that the portfolio’s returns and the S&P 500’s returns are not equivalent. If the investor conducted a one-tailed test, the alternative hypothesis would state that the portfolio’s returns are either less than or greater than the S&P 500’s returns.
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