Probability
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The study of chance providing an objective measure of uncertainty.
Probabilities range between 1 (= 100%) and 0 (= 0%).
A probability of 100% means that an event is considered certain to occur.
A probability of 0% means that an event is considered certain not to occur.
For example, flipping an unbiased coin, the probability of getting a head is often modelled as 50%.
The problem
This simple model of a coin flip assumes that the only two possibilities are a head or a tail.
Applying such simple models to financial situations, and treating financial outcomes as simple coin flips, may lead to errors resulting from:
- The coin landing on its edge 'more often than it's supposed to'.
- The underlying assumption of an unbiased coin not being a valid one. This kind of assumption is usually much too simple.
