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Testing a Modeling Assumption

EasyStatistics & Probability00:00
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Problem

Scenario

You are about to use a historical return assumption in a financial model, and you want to check whether the assumed average is supported by observed data. Before using it, you need to decide if the assumption is reasonable.

Question

How do you test whether a financial assumption is reasonable before using it in a model?

What this tests

  • Translate an assumption into a null hypothesis
  • Use a one-sample test to compare data with the assumed value
  • Interpret both the p-value and the confidence interval
  • Explain what the result means for model inputs