What is the cleanest way to remember Type I and Type II errors for CFA Level I?
Tie the error to your decision. A Type I error happens when you reject a null hypothesis that is actually true. It is a false alarm. A Type II error happens when you fail to reject a null hypothesis that is actually false. It is a missed detection.
For example, if the null says a manager has zero alpha and you reject it even though the manager truly has zero alpha, that is Type I. If the manager truly has positive alpha but your test fails to reject zero alpha, that is Type II. The significance level controls the probability of Type I error when the null is true. Power is the probability of rejecting the null when the alternative is true.
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