Martingale (Probability Theory) - Wikipedia, The Free Encyclopedia

5/5/2014 Martingale (probability theory) - Wikipedia, the free encyclopedia
http://en.wikipedia.org/wiki/Martingale_(probability_theory) 1/9
Stopped Brownian motion is an example of a martingale. It
can model an even coin-toss betting game with the
possibility of bankruptcy.
Martingale (probability theory)
From Wikipedia, the free encyclopedia
For the martingale betting strategy, see martingale (betting system).
In probability theory, a martingale is a model of a
fair game where knowledge of past events never
helps predict the mean of the future winnings. In
particular, a martingale is a sequence of random
variables (i.e., a stochastic process) for which, at a
particular time in the realized sequence, the
expectation of the next value in the sequence is equal
to the present observed value even given knowledge
of all prior observed values at a current time.
To contrast, in a process that is not a martingale, it
may still be the case that the expected value of the
process at one time is equal to the expected value of
the process at the next time. However, knowledge of
the prior outcomes (e.g., all prior cards drawn from a
card deck) may be able to reduce the uncertainty of
future outcomes. Thus, the expected value of the next
outcome given knowledge of the present and all prior
outcomes may be higher than the current outcome if
a winning strategy is used. Martingales exclude the possibility of winning strategies based on game history, and thus
they are a model of fair games.
Contents
1 History
2 Definitions
2.1 Martingale sequences with respect to another sequence
2.2 General definition
3 Examples of martingales
4 Submartingales, supermartingales, and relationship to harmonic functions
4.1 Examples of submartingales and supermartingales
5 Martingales and stopping times
6 See also
7 Notes
8 References
History
Originally, martingale referred to a class of betting strategies that was popular in 18th-century France.
[1][2]
The
simplest of these strategies was designed for a game in which the gambler wins his stake if a coin comes up heads
and loses it if the coin comes up tails. The strategy had the gambler double his bet after every loss so that the first
win would recover all previous losses plus win a profit equal to the original stake. As the gambler's wealth and
available time jointly approach infinity, his probability of eventually flipping heads approaches 1, which makes the
martingale betting strategy seem like a sure thing. However, the exponential growth of the bets eventually bankrupts
its users, assuming the obvious and realistic i.e. finite bankrolls (one of the reasons casinos, though normatively
enjoying a mathematical edge in the games offered to their patrons, impose betting limits). Stopped Brownian
motion, which is a martingale process, can be used to model the trajectory of such games.
The concept of martingale in probability theory was introduced by Paul Lvy in 1934, though he did not name them:
the term "martingale" was introduced later by Ville (1939), who also extended the definition to continuous
martingales. Much of the original development of the theory was done by Joseph Leo Doob among others. Part of
the motivation for that work was to show the impossibility of successful betting strategies.
Definitions
A basic definition of a discrete-time martingale is a discrete-time stochastic process (i.e., a sequence of random
variables) X
1
, X
2
, X
3
, ... that satisfies for any time n,
That is, the conditional expected value of the next observation, given all the past observations, is equal to the last
observation. Due to the linearity of expectation, this second requirement is equivalent to:
or
which states that the average "winnings" from observation to observation are 0.
Martingale sequences with respect to another sequence
More generally, a sequence Y
1
, Y
2
, Y
3
... is said to be a martingale with respect to another sequence
X
1
, X
2
, X
3
... if for all n
Similarly, a continuous-time martingale with respect to the stochastic process X
t
is a stochastic process Y
t
such
that for all t
This expresses the property that the conditional expectation of an observation at time t, given all the observations
up to time , is equal to the observation at time s (of course, provided that s t).
General definition
In full generality, a stochastic process is a martingale with respect to a filtration and
probability measure P if
is a filtration of the underlying probability space (, , P);

Y is adapted to the filtration
, i.e., for each t in the index set T, the random variable Y

t
is a
t
-measurable
function;
for each t, Y
t
lies in the L
p
space L
1
(,
t
, P; S), i.e.
for all s and t with s < t and all F
s
,
where
F
denotes the indicator function of the event F. In Grimmett and Stirzaker's Probability and
Random Processes, this last condition is denoted as
which is a general form of conditional expectation.
[3]
It is important to note that the property of being a martingale involves both the filtration and the probability measure
(with respect to which the expectations are taken). It is possible that Y could be a martingale with respect to one
measure but not another one; the Girsanov theorem offers a way to find a measure with respect to which an It
process is a martingale.
Examples of martingales
An unbiased random walk (in any number of dimensions) is an example of a martingale.
A gambler's fortune (capital) is a martingale if all the betting games which the gambler plays are fair.
Polya's urn contains a number of different coloured marbles, and each iteration a marble is randomly selected
out of the urn and replaced with several more of that same colour. For any given colour, the ratio of marbles
inside the urn with that colour is a martingale. For example, if currently 95% of the marbles are red then
though the next iteration is much more likely add more red marblesthis bias is exactly balanced out by the
fact that adding more red marbles alters the ratio much less significantly than adding the same number of non-
red marbles would.
Suppose X
n
is a gambler's fortune after n tosses of a fair coin, where the gambler wins $1 if the coin comes
up heads and loses $1 if the coin comes up tails. The gambler's conditional expected fortune after the next
trial, given the history, is equal to his present fortune, so this sequence is a martingale.
Let Y
n
= X
n
2
n where X
n
is the gambler's fortune from the preceding example. Then the sequence { Y
n
: n
= 1, 2, 3, ... } is a martingale. This can be used to show that the gambler's total gain or loss varies roughly
between plus or minus the square root of the number of steps.
(de Moivre's martingale) Now suppose an "unfair" or "biased" coin, with probability p of "heads" and
probability q = 1 p of "tails". Let
with "+" in case of "heads" and "" in case of "tails". Let
Then { Y
n
: n = 1, 2, 3, ... } is a martingale with respect to { X
n
: n = 1, 2, 3, ... }. To show this
(Likelihood-ratio testing in statistics) A population is thought to be distributed according to either a
probability density f or another probability density g. A random sample is taken, the data being X
1
, ..., X
n
.
Let Y
n
be the "likelihood ratio"
(which, in applications, would be used as a test statistic). If the population is actually distributed according to
the density f rather than according to g, then { Y
n
: n = 1, 2, 3, ... } is a martingale with respect to
Software-created martingale series.
{ X
n
: n = 1, 2, 3, ... }.
Suppose each amoeba either splits into two amoebas, with probability p, or eventually dies, with probability
1 p. Let X
n
be the number of amoebas surviving in the nth generation (in particular X
n
= 0 if the population
has become extinct by that time). Let r be the probability of eventual extinction. (Finding r as function of p is
an instructive exercise. Hint: The probability that the descendants of an amoeba eventually die out is equal to
the probability that either of its immediate offspring dies out, given that the original amoeba has split.) Then
is a martingale with respect to { X
n
: n = 1, 2, 3, ... }.
In an ecological community (a group of species that are in a
particular trophic level, competing for similar resources in a
local area), the number of individuals of any particular species
of fixed size is a function of (discrete) time, and may be
viewed as a sequence of random variables. This sequence is
a martingale under the unified neutral theory of biodiversity
and biogeography.
If { N
t
: t 0 } is a Poisson process with intensity , then the
compensated Poisson process { N
t
t : t 0 } is a
continuous-time martingale with right-continuous/left-limit
sample paths.
Wald's martingale
Submartingales, supermartingales, and relationship to harmonic
functions
There are two popular generalizations of a martingale that also include cases when the current observation X
n
is not
necessarily equal to the future conditional expectation E[X
n+1
|X
1
,...,X
n
] but instead an upper or lower bound on
the conditional expectation. These definitions reflect a relationship between martingale theory and potential theory,
which is the study of harmonic functions. Just as a continuous-time martingale satisfies E[X
t
|
{X
: s}] X
s
= 0 s t, a harmonic function f satisfies the partial stochastic differential equation f = 0 where
is the Laplacian operator. Given a Brownian motion process W
t
and a harmonic function f, the resulting process
f(W
t
) is also a martingale.
A discrete-time submartingale is a sequence of integrable random variables satisfying
Likewise, a continuous-time submartingale satisfies
In potential theory, a subharmonic function f satisfies f 0. Any subharmonic function that is bounded
above by a harmonic function for all points on the boundary of a ball are bounded above by the harmonic
function for all points inside the ball. Similarly, if a submartingale and a martingale have equivalent
expectations for a given time, the history of the submartingale tends to be bounded above by the history of
the martingale. Roughly speaking, the prefix "sub-" is consistent because the current observation X
n
is less
than (or equal to) the conditional expectation E[X
n+1
|X
1
,...,X
n
]. Consequently, the current observation
provides support from below the future conditional expectation, and the process tends to increase in future
time.
Analogously, a discrete-time supermartingale satisfies
Likewise, a continuous-time supermartingale satisfies
In potential theory, a superharmonic function f satisfies f 0. Any superharmonic function that is bounded
below by a harmonic function for all points on the boundary of a ball are bounded below by the harmonic
function for all points inside the ball. Similarly, if a supermartingale and a martingale have equivalent
expectations for a given time, the history of the supermartingale tends to be bounded below by the history of
the martingale. Roughly speaking, the prefix "super-" is consistent because the current observation X
n
is
greater than (or equal to) the conditional expectation E[X
n+1
|X
1
,...,X
n
]. Consequently, the current
observation provides support from above the future conditional expectation, and the process tends to
decrease in future time.
Examples of submartingales and supermartingales
Every martingale is also a submartingale and a supermartingale. Conversely, any stochastic process that is
both a submartingale and a supermartingale is a martingale.
Consider again the gambler who wins $1 when a coin comes up heads and loses $1 when the coin comes up
tails. Suppose now that the coin may be biased, so that it comes up heads with probability p.
If p is equal to 1/2, the gambler on average neither wins nor loses money, and the gambler's fortune
over time is a martingale.
If p is less than 1/2, the gambler loses money on average, and the gambler's fortune over time is a
supermartingale.
If p is greater than 1/2, the gambler wins money on average, and the gambler's fortune over time is a
submartingale.
A convex function of a martingale is a submartingale, by Jensen's inequality. For example, the square of the
gambler's fortune in the fair coin game is a submartingale (which also follows from the fact that X
n
2
n is a
martingale). Similarly, a concave function of a martingale is a supermartingale.
Martingales and stopping times
Main article: Stopping time
A stopping time with respect to a sequence of random variables X
1
, X
2
, X
3
, ... is a random variable with the
property that for each t, the occurrence or non-occurrence of the event = t depends only on the values of
X
1
, X
2
, X
3
, ..., X
t
. The intuition behind the definition is that at any particular time t, you can look at the sequence so
far and tell if it is time to stop. An example in real life might be the time at which a gambler leaves the gambling
table, which might be a function of his previous winnings (for example, he might leave only when he goes broke),
but he can't choose to go or stay based on the outcome of games that haven't been played yet.
In some contexts the concept of stopping time is defined by requiring only that the occurrence or non-occurrence
of the event = t be probabilistically independent of X
t + 1
, X
t + 2
, ... but not that it be completely determined by the
history of the process up to time t. That is a weaker condition than the one appearing in the paragraph above, but is
strong enough to serve in some of the proofs in which stopping times are used.
One of the basic properties of martingales is that, if is a (sub-/super-) martingale and is a stopping
time, then the corresponding stopped process defined by is also a (sub-/super-)
martingale.
The concept of a stopped martingale leads to a series of important theorems, including, for example, the optional
stopping theorem which states that, under certain conditions, the expected value of a martingale at a stopping time is
equal to its initial value.
See also
Azuma's inequality
Brownian motion
Martingale central limit theorem
Martingale representation theorem
Doob martingale
Doob's martingale convergence theorems
Local martingale
Semimartingale
Martingale difference sequence
Markov chain
Martingale (betting system)
Notes
1. ^ Balsara, N. J. (1992). Money Management Strategies for Futures Traders. Wiley Finance. p. 122. ISBN 0-471-
52215-5.
2. ^ Mansuy, Roger (June 2009). "The origins of the Word "Martingale""
(http://www.jehps.net/juin2009/Mansuy.pdf). Electronic Journal for History of Probability and Statistics 5 (1).
Retrieved 2011-10-22.
3. ^ Grimmett, G.; Stirzaker, D. (2001). Probability and Random Processes (3rd ed.). Oxford University Press.
ISBN 0-19-857223-9.
References
Hazewinkel, Michiel, ed. (2001), "Martingale" (http://www.encyclopediaofmath.org/index.php?
title=p/m062570), Encyclopedia of Mathematics, Springer, ISBN 978-1-55608-010-4
"The Splendors and Miseries of Martingales" (http://www.jehps.net/juin2009.html). Electronic Journal for
History of Probability and Statistics 5 (1). June 2009. Entire issue dedicated to Martingale probability
theory.
Williams, David (1991). Probability with Martingales. Cambridge University Press. ISBN 0-521-40605-
6.
Kleinert, Hagen (2004). Path Integrals in Quantum Mechanics, Statistics, Polymer Physics, and
Financial Markets (http://www.physik.fu-berlin.de/~kleinert/b5) (4th ed.). Singapore: World Scientific.
ISBN 981-238-107-4.
Siminelakis, Paris (2010). "Martingales and Stopping Times: Use of martingales in obtaining bounds and
analyzing algorithms" (http://www.corelab.ece.ntua.gr/courses/rand-alg/slides/Martingales-
Stopping_Times.pdf) (PDF). University of Athens.
Ville, Jean (1939), tude critique de la notion de collectif (http://books.google.com/books?
id=ETY7AQAAIAAJ), Monographies des Probabilits (in French) 3, Paris: Gauthier-Villars, Zbl 0021.14601
(http://www.zentralblatt-math.org/zmath/en/search/?format=complete&q=an:0021.14601), Review by Doob
(http://dx.doi.org/10.1090/S0002-9904-1939-07089-4)
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is a filtration of the underlying probability space (, , P);

, i.e., for each t in the index set T, the random variable Y

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