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101 Concepts for the Level I Exam

Concept 14: Steps of Hypothesis Testing


Hypothesis is a statement about the value of a population parameter developed for the purpose of testing a theory.

Hypothesis testing is the process of assessing the accuracy of a statement about a population on the basis of analysis conducted on a sample. In order to test a hypothesis, we follow the following steps:

  1. State the hypothesis.
  2. Identify the appropriate test statistic.
  3. Specify the level of significance.
  4. State a decision rule to accept or reject the hypothesis.
  5. Collect sample data and calculate the test statistic.
  6. Decide if the hypothesis can be accepted/rejected.
  7. Make an economic or investment decision.

Null hypothesis (H0is the hypothesis that the researcher wants to reject. It should always include the ‘equal to’ condition.

Alternative hypothesis (Hais the hypothesis that the researcher wants to prove. If the null hypothesis is rejected, then the alternative hypothesis is considered valid.

If you want to test if the average returns of all stocks in the S&P 500 are greater than 10%.

H0: µ ≤ 10% and Ha: µ > 10%

If you want to test if the average returns of all stocks in the S&P 500 are less than 10%.

H0: µ ≥ 10% and Ha: µ < 10%

If you want to test if the average returns of all stocks in the S&P 500 are not equal to 10%.

H0: µ = 10% and Ha: µ ≠ 10%