Hello… Please can Anyone break this down… why is this a type1 error?
If markets are mean-reverting, Type I errors can occur when firing a manager with poor performance, only to have performance improve subsequently because of mean reversion…
Type I and Type II error can totally be confusing, at least depends on the hypothesis from the statistical perspective. but at a high level, Type I (false positives) can be interpreted as predicted something but turned out to be wrong. Type II (false negatives) as predicted not be something but turned out did - opportunity cost. Firing a poor performer can be a positive as you predict the manager will suck at the job, and fire is the action to take. This part can be confusing. For example, if the action is to reward high performers, then the prediction of lower performer and decide not to reward will be a negative. True or False, that depends on how it turned out to be. Mean-reverting in this case indicates you made the wrong call, so as it is a false positive in my opinion.
Thank you…
So is firing not same as “manager is not good” = negative which can now turn to false negative after mean reversion turns the performance around…Pls explain
Anyways, how does type 1 and 2 increase cost… I can relate with type 1 = you mistakenly recruit a bad manager cos of short perf… when the market turns bad then you are stuck with bad mgr in a bad market = Double warming… Is that assumption correct ? also Pls can you assist with type 2
I also tried to rationalise why there is more cost of Type 1 or 2 error… type 1 looks clear to me based on this understanding….Pls confirm if my interpretation is right
When you hire/retain a manager because of temporary success, by the time market goes bad then you are stuck with a bad manager in a bad market – Double negative situation so potential huge loss
But type 2 appears to me to be less cost… can you help?
Not employing a manager or firing because of temporary bad performance will leave you with a good market when the market picks up though you might not have the right manager but at least the market is good and you are likely to do well or reasonably so how can this be costly?