Markets: A Rigorous Course

M12 · Problem 9 ★★ Check

Bayes by hand

Use the prior (0.5,0.3,0.2)(0.5,0.3,0.2) over (deal, stalemate, escalation) from 12.5. (a) Reproduce the posterior after news 1 (likelihoods 0.2,0.6,0.90.2,0.6,0.9) and then news 2 (likelihoods 0.8,0.5,0.10.8,0.5,0.1). Show every step. (b) What likelihood ratio, escalation against "not escalation", is needed to move P(escalation)P(\text{escalation}) from 0.2 to 0.5? (c) Verify that applying the two news items in reverse order gives the same posterior.

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