GENERAL  ARTICLE
Mathematics of Risk Taking
(left) K B Athreya is a
visiting professor at IMI,
Mathematics Department,
IISc, Bangalore and is also
a professor of mathematics
and statistics at Iowa State
University, Ames, Iowa,
USA. His research
interests include math-
ematical analysis,
probability theory and its
applications and statistics.
His spare time is spent
listening to Indian classical
music.
(right) M G Nadkarni is
emeritus professor at
university of Mumbai. He
has contributed to
descriptive and spectral
aspects of ergodic theory.
Keywords
Investor, risk taking, fair game,
martingale, random walk, gam-
bling, population.
66
K B Athreya and M G Nadkarni
A sim p le m a th e m a tic a l m o d e l fo r a n in v e sto r's
g a in s a n d lo sse s o v e r tim e s h o w s th a t, in th e
lo n g ru n , th o se w ith la rg e su m s to in v e st h a v e
a n e x c e lle n t c h a n c e o f re a ch in g th e ir g o a l w h ile
th e m a r g in a l in v e sto rs h a v e a h ig h p r o b a b ility o f
g o in g b a n k ru p t. A g r e e d y in v e sto r, r ic h o r p o o r,
w ill h it th e b o tto m in th e lo n g ru n , w ith p ro b -
a b ility o n e . C o n se q u e n c e s fo r th e p o p u la tio n a t
la r g e a re d isc u sse d .
1 . In tro d u c tio n
Is g a m b lin g g o o d fo r y o u ? T h e a n sw er is, o f co u rse, N o .
N o t ju st fo r m o ra l o r eth ica l rea so n s, sin ce g a m b lin g is
a p erv erse w ay o f risk ta k in g , b u t fo r g o o d p ra ctica l
rea so n s b a sed o n so m e so u n d a n d sim p le m a th em a tics.
M a th em a tics, lik e p h ilo so p h er's G o d , is im p erso n a l, a n d
th e m a th em a tics o f risk ta k in g is in d ep en d en t o f w h o
is ta k in g risk a n d fo r w h a t p u rp o se. S o th e a rticle is
a lso a b o u t th e g en u in e a n d n eed ed risk ta k in g o f en -
trep ren eu rs (w h ich in clu d es farm ers), b u sin essm en a n d
in v esto rs.
O u r m a in resu lts a re in S ectio n s 2 a n d 3 . T h e im p li-
ca tio n s fo r th e p o p u la tio n a t la rg e a re d iscu ssed in S ec-
tio n 4 .
2 . A S im p le G a m b lin g S ch e m e (a lso k n o w n a s
S im p le S y m m e tric R a n d o m W a lk )
S u p p o se th e g a m b lin g sch em e co n sists o f to ssin g a fa ir
co in , (i.e., th e p ro b a b ility o f th e co in fa llin g h ea d s is 1 / 2 ,
w h ich is a lso th e p ro b a b ility o f ta ils). A t ea ch to ss th e
g a m b ler receiv es o n e ru p ee from th e g a m b lin g h o u se if
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 GENERAL  ARTICLE

th e co in fa lls h ea d s u p , a n d sh e g iv es o n e ru p ee to th e
Simple Random Walk
g a m b lin g h o u se if it fa lls ta ils u p . S u p p o se th e g a m b ler
sta rts w ith a n in itia l ca p ita l o f R s.a > 0 , a n d let u s At time zero start at some
su p p o se th a t sh e w ish es to in crea se it to R s.N > a a n d integer a. Then toss a coin
th a t sh e sto p s g a m b lin g a s so on a s th e g o a l N rea ch ed . whose probability for
In ca se th e g a m b ler rea ch es 0 , b efo re rea ch in g N , th en ‘heads’ is p , 0 < p < 1. If
to o th e g a m e sto p s sin ce th e g am b ler h a s n o m o n ey left ‘heads’, move to the right
to g a m b le. one step, i.e., to (a + 1) and
if ‘tails’, move to the left
W h a t d o y o u th in k w ill h a p p en ? one step , i.e., to (a – 1).
This is your position at time
C lea rly th ere a re th ree ev en ts p o ssib le: one. Now repeat this at each
1 ) T h e to ssin g o f th e co in co n tin u es in d e¯ n itely, i.e., th e time step with the tosses
being independent. The tra-
g a m b ler n ev er a cco m p lish es th e g o a l o f rea ch in g N , n o r
jectory you generate is
d o es sh e b eco m e b a n k ru p t b y rea ch in g 0 .
called a simple random
2 ) T h e g a m b ler a cco m p lish es th e g o a l o f rea ch in g N in walk with initial value a
a ¯ n ite n u m b er o f step s (b efore rea ch in g 0 ) a n d sto p s and parameter p. If p = 1/2
g a m b lin g a n y fu rth er. then it is called simple sym-
metric random walk.
3 ) T h e g a m b ler b eco m es b a n k ru p t, i.e., rea ch es 0 in a
¯ n ite n u m b er o f to sses (b efo re rea ch in g N ) so th e g a m e This model is of relevance
sto p s. in many areas of science
such as physics, operations
T h e fo llow in g p ro p o sitio n is a co n seq u en ce o f m o re g en - research, mathematical fi-
era l co n sid era tio n s o f th e n ex t sectio n (w h ich in clu d es nance and population ge-
th e a b ov e g a m b lin g sch em e a s a sp ecia l ca se). netics.

P r o p o sitio n 2 .1 (i) T he probability of the ¯ rst even t is

zero or equ ivalen tly, the gam blin g w ill alm ost su rely en d
in a ¯ n ite n u m ber of tosses,
(ii) the probability of even t (2) of the gam bler reachin g
N in a ¯ n ite n u m ber of tosses (before reachin g 0, i.e.,
becom in g ban kru pt) is Na , w here a is the in itial capital
of the gam bler,
(iii) the probability of even t (3) of the gam bler becom in g
ban kru pt in ¯ n ite n u m ber of tosses is 1 ¡ Na .
T h u s, fo r ex a m p le, if N = 1 0 7 (a cro re), th e g a m b ler's

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 GENERAL  ARTICLE

ch a n ces o f b eco m in g a cro rep a ti a re h ig h , say 0 .7 o r

m o re if h er in itia l ca p ita l a is 7 0 la k h s o r m o re. O n th e
o th er h a n d if h er ca p ita l is 3 la k h s o r less, h er ch a n ces
o f b eco m in g a cro rep a ti is o n ly 0 .0 3 o r less. T h u s a rich
g a m b ler h a s a h ig h er p ro b a b ility o f rea ch in g h er g o a l
th a n a p o o r o n e.
T h e a b ov e g a m b lin g sch em e m ay a lso b e v iew ed a s a
k in d o f w a lk , ca lled sim p le sy m m etric ra n d o m w a lk w ith
a b so rb in g b a rriers. C o n sid er a p erso n sta rtin g a t a p o s-
itiv e in teg er a , 0 < a < N , a n d ex ecu tin g a w a lk a lo n g
th e x -a x is a s fo llow s: sh e to sses a fa ir co in a n d ta k es a
step o f u n it len g th in p o sitiv e d irectio n if th e co in fa lls
h ea d s u p , a n d sh e ta k es a step o f u n it len g th in th e n eg -
a tiv e d irectio n if th e co in fa lls ta ils u p . T h e p ro cess is
rep ea ted a t th e p erso n 's n ew p o sitio n , a n d so o n . T h e
w a lk sto p s a s so o n a s th e p erso n rea ch es 0 o r N , th ese
b ein g th e a b so rb in g b a rriers. P ro p o sitio n 2 .1 say s th a t
th e w a lk w ill en d in a ¯ n ite n u m b er o f step s w ith p ro b -
a b ility o n e a n d th a t th e p ro b a b ilities o f rea ch in g N a n d
0 a re Na a n d 1 ¡ Na resp ectiv ely.
L et X i d en o te th e g a m b ler's p o ssib le ca p ita l a t tim e i.
It is a ra n d o m va ria b le. A ssu m e th a t th e g a m e h a s n o t
sto p p ed u p to th e n th to ss a n d th a t a 1 ;a 2 ;¢¢¢;a n a re
resp ectiv ely th e ca p ita l o f th e ga m b ler a fter th e 1 st, 2 n d
¢¢¢, n th to ss. T h e seq u en ce (a 1 ;a 2 ;¢¢¢;a n ) is ca lled th e
p a th o f th e g a m b ler's ca p ita l (o r fo rtu n e) u p to tim e n .
L et P (A j B ) d en o te th e co n d itio n a l p ro b a b ility o f a n
ev en t A g iv en th a t a n ev en t B h a s o ccu red . T h e sim p le
g a m b lin g sch em e o r th e sim p le sy m m etric ra n d o m w a lk
X i;i = 1 ;2 ;3 ;¢¢¢ is M arkovian , w h ich m ea n s th a t, fo r
a ll n ¸ 1 , a n d a n y in teg er x , 0 · x · N , a n d a n y
a 1 ;a 2 ;¢¢¢;a n ,
P (X n+ 1 = x jX 1 = a 1 ;X 2 = a 2 ;¢¢¢;X n = an )
= P (X n+ 1 = x jX n = a n ):
In o th er w o rd s, th e co n d itio n a l p ro b a b ility d istrib u tio n
o f X n + 1 , g iv en th e p a th o f th e g a m b ler's ca p ita l u p to

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tim e n , d ep en d s en tirely o n th e ca p ita l o f th e g a m b ler

at tim e n , a n d n o t o n th e p a th o f h er ca p ita l u p to tim e
n . T h a t is, g iv en th e `p resen t', i.e., th e va lu e X n a t tim e
n , th e `p a st', i.e., X j , j · n ¡ 1 is n o t releva n t fo r th e
p ro b a b ility d istrib u tio n o f th e `fu tu re', i.e., X n + !.
In th e n ex t sectio n w e w ill d iscu ss a g a m b lin g sch em e
m o re g en era l th a n th e sim p le sy m m etric ra n d o m w a lk .
T h is sch em e a llow s th e g a m b ler to b et a m o u n ts m o re
th a n o n e ru p ee, a n d a t th e sa m e tim e a llow s h er th e
freed o m to d ecid e o n h ow m u ch to b et (b u t n o t m o re
th a n N ) a t a n y g iv en tim e. M o reov er, sh e ca n d ecid e
th is a m o u n t (o f h ow m u ch to b et) b a sed o n th e en tire
p a th o f h er ca p ita l u p to th a t tim e. T h a t is, sh e ca n b e
n o n -M a rk ov ia n .
S in ce it is th e ca refu l in v esto r, ra th er th a n a n im p u lsiv e
g a m b ler, w h o ta k es in to a cco u n t th e h isto ry o f th e m a r-
k et b efo re rea d ju stin g h er p o rtfo lio , w e w ill ch a n g e o u r
la n g u a g e a n d sp ea k in term s o f so b er a n d ca lcu la tin g
in v esto r ra th er th a n a co m p u lsiv e g a m b ler. It is im p o r-
ta n t to n o te th a t a n in v esto r n eed n o t b e a n in d iv id u a l,
b u t ca n b e a co m p a n y, sm a ll o r la rg e, a co rp o ra tio n , a
g ov ern m en t b o d y, a ch a rita b le o rg a n iza tio n o r tru st o r
a n y o th er su ch in stitu tio n .
3 . A n In v e sto r 's M a rtin g a le W a lk : T h e C a se o f
a S in g le In v e sto r
W e w ill n ow co n sid er a sim p le g en era liza tio n o f th e a b ov e
m o d el. A t tim e 0 th e in v esto r in v ests a n a m o u n t a ,
0 < a < N , w ith th e h o p e o f receiv in g a ¯ x ed h ig h er
a m o u n t b, a < b · N , a t tim e 1 b u t is aw a re th a t
sh e m ay lo o se in th e p ro cess, a n d is w illin g to receiv e a
sm a ller a m o u n t c, 0 · c < a . T h e q u a n tities a ;b a n d c
a re ch o sen b y th e in v esto r a t th e sta rt. If sh e receiv es
th e a m o u n t b a t tim e 1 th en h er g a in g is b ¡ a , w h ile
if sh e receiv es th e a m o u n t c a t tim e 1 th en h er lo ss l is
a ¡ c. N o te th a t b ¡ c = b ¡ a + a ¡ c = g + l. T h e

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 GENERAL  ARTICLE

p ro b a b ilities x = p (b), y = p (c) th a t th e in v esto r receiv es

Martingale
th e a m o u n t b o r c a t tim e 1 resp ectiv ely a re d eterm in ed
b y th e sim u lta n eo u s eq u a tio n s:
The property that the aver-
age value of an investment
portfolio at time (n + 1) x + y = 1; (1 )
over the random market
fluctuations equals the bx + cy = a ; (2 )
value at time n is known as w h ich g iv es
the martingale property. It
is of great importance in a¡ c l b¡ a g
financial mathematics.
x = p (b) = = ; y = p (c) = = :
b¡ c g+ l b¡ c g+ l

T h e req u irem en t bp (b) + cp (c) = a is k n ow n a s fair gam e

o r m artin gale co n d itio n in p ro b a b ility th eo ry. It is a
co n seq u en ce o f n o arbitrage opportu n ities req u irem en t
in ¯ n a n cia l m a th em a tics. It say s th a t o n a n a v era g e
ea ch in v esto r n eith er lo ses o r g a in s a t ea ch step . If th is
w ere n o t so a n d , say, th e in v esto r ca n ex p ect to g a in
th en a lo t o f in v esto rs w ill ju m p in a n d th e g a in w ill b e
lo st. O n th e o th er h a n d if o n a n av era g e y o u ex p ect to
lo se th en n o in v esto r w ill w a n t to stay in th e m a rk et.
T h u s (2 ) is a rea so n a b le a ssu m p tio n .
W e ca n rew rite th is co n d itio n a s g p (b) ¡ lp (c) = 0 . S in ce
a is ¯ x ed , w e m ay th in k o f p (b) a lso a s th e p ro b a b ility
P (g ) o f th e in v esto r m a k in g a g a in o f a m o u n t g w h ile
p (c) m ay b e in terp reted a s th e p ro b a b ility P (l) th a t th e
in v esto r m a k es a lo ss o f a m o u n t l, so th a t th e fa ir g a m e
o r m a rtin g a le co n d itio n b eco m es

g P (g ) ¡ lP (l) = 0 ;

w h ich is in terp reted to m ea n th a t o n a n av era g e th e

in v esto r w ill b rea k ev en .
F ro m th e eq u a tio n s
l g
P (g ) = ; P (l) = ;
g+ l g+ l

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w e n o te a t o n ce th a t l · g if a n d o n ly if P (g ) · P (l),
so th a t u n d er th e m a rtin g a le co n d itio n (2 ) a `la rg e' g a in
is p o ssib le o n ly w ith `sm a ll' p ro b a b ility, w h ile a `sm a ll'
g a in is p o ssib le w ith `h ig h ' p ro b a b ility, in w h ich ca se
th e lo ss is `b ig ' sh o u ld th e in v esto r b e u n lu ck y to lo o se.
T h u s, th ese eq u a tio n s m ay b e v iew ed a s eq u a tio n s o f
th e sta tu to ry w a rn in g in fa st fo rw a rd a n d sm a ll p rin t:
`m u tu a l fu n d in v estm en ts a re su b ject to m a rk et risk ,
rea d th e o ® er d o cu m en t ca refu lly b efo re in v estin g '.
T h e term `fa ir g a m e' co m es fro m cla ssica l b ettin g co n -
sid era tio n s (see D o o b [1 ], F eller [2 ]) w h ere a g a m b ler is
su p p o sed to b e p lay in g a g a in st a g a m b lin g h o u se, a n d
th e ro le o f th e in v esto r is rep la ced b y th a t o f th e g a m -
b ler. If a is th e a m o u n t th e g a m b ler b ets, a n d receiv es
a n a m o u n t b > a if sh e w in s a n d a n a m o u n t c < a if sh e
lo ses, th en th e g a m e is sa id to b e fav o ra b le to th e g a m -
b ler if bp (b)+ cp (c) > a , w h erea s it is sa id to b e fav o ra b le
to th e g a m b lin g h o u se if bp (b) + cp (c) < a , a n d , fa ir if
th e eq u a lity h o ld s. H ere, a s b efo re, p (b);p (c) d en o te th e
p ro b a b ilities o f th e g a m b ler receiv in g th e a m o u n t b a n d
c resp ectiv ely. W e n o te th a t th e `fa ir g a m e' co n d itio n
a lso seem s to b e fa ir b etw een a n y tw o in v esto rs, rich o r
p o o r, b eca u se th e p ro b a b ilities P (g ) a n d P (l) o f g a in
a n d lo ss d ep en d en tirely o n g a n d l a n d n o t o n th e in i-
tia l in v estm en t a . H ow ev er, th ese co n clu sio n s o f fa irn ess
b etw een th e m a rk et fo rces a n d th e in v esto r o r b etw een
tw o in v esto rs a re d ecep tiv e a s w e w ill see.
If th e in v esto r ch o o ses to a ttem p t to m a k e fu ll g a in ,
i.e., ch o o ses b = N , a n d is lu ck y en o u g h to receiv e th e
a m o u n t N a t tim e 1 , th en sh e is co n ten ted a n d d o es
n o t in v est a n y m o re. S im ila rly if sh e ch o o ses c = 0 a n d
is u n lu ck y en o u g h to lo o se, th en a t tim e 1 sh e h a s n o
ca p ita l to in v est, so th a t sh e d o es n o t in v est a n y m o re.
In ca se sh e receiv es a n a m o u n t d a t tim e 1 w h ich ca n
b e eith er b o r c, a n d if 0 < d < N , th en sh e in v ests
th e a m o u n t d h o p in g to o b ta in a ¯ x ed h ig h er a m o u n t e,
d < e · N a t tim e 2 , b u t is w illin g to receiv e a ¯ x ed

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sm a ller a m o u n t f , 0 · f < a , sh o u ld sh e lo o se. T h e

p ro b a b ilities p (e);p (f ), w h o se su m is o n e, a re a g a in d e-
term in ed b y th e `fa ir g a m e' co n d itio n f p (f ) + ep (e) = d .
T h e p ro cess co n tin u es. S o m e ca re is req u ired to d escrib e
th e situ a tio n a t tim e n . L et x i d en o te th e a m o u n t th e
in v esto r receiv es a t tim e i, o r a lrea d y h a s th is a m o u n t
a t tim e i, (w h ich is th e ca se if x i¡1 = 0 o r N ). If a t tim e
n th e in v esto r h a s a m o u n t x n a n d if x n = 0 o r N , th en
sh e d o es n o t in v est a n y m o re. O th erw ise 0 < x n < N , in
w h ich ca se sh e in v ests th is a m o u n t a g a in ch o o sin g n ew
q u a n tities, say ® a n d ¯ , 0 · ® < x n , x n < ¯ · N ,
w h ich sh e is w illin g to receiv e a t tim e n + 1 .
T h ese q u a n tities ca n d ep en d o n x 0 = a ;x 1 ;x 2 ;¢¢¢;x n ,
sin ce th e in v esto r ch o o ses ® a n d ¯ k eep in g in m in d th e
h isto ry o f th e m a rk et a n d th e w o rld u p to tim e n . T h e
p ro b a b ilities p (® ) a n d p (¯ ) w ith w h ich th ese va lu es a re
rea lized sa tisfy (1 ) a n d (2 ), i.e.,

p (® ) + p (¯ ) = 1 ; (3 )

® p (® ) + ¯ p (¯ ) = x n (fair g a m e co n d itio n ): (4 )
T h u s,
¯ ¡ xn xn ¡ ®
p (® ) = ; p (¯ ) = : (5 )
¯ ¡ ® ¯ ¡ ®

L et p (x 1 ;x 2 ;¢¢¢;x n ) d en o te th e p ro b a b ility th a t th e in -
v esto r receiv es a n a m o u n t x 1 a t tim e 1 , x 2 a t tim e 2 ,
a n d in g en era l, a n a m o u n t x n a t tim e n . L et p (x n + 1 j
x 1 ;x 2 ;¢¢¢;x n ) d en o te th e co n d itio n a l p ro b a b ility th a t
th e in v esto r receiv es a n a m o u n t x n + 1 a t tim e n + 1 g iv en
th a t sh e h a s receiv ed a n a m o u n t x 1 a t tim e 1 , x 2 a t tim e
2 , a n d in g en era l a n a m o u n t x n a t tim e n .
R eca ll th a t fo r a n y tw o ev en ts A a n d B , th e p ro b a b ility
o f A a n d B h a p p en in g to g eth er, P (A \ B ), a n d th e
co n d itio n a l p ro b a b ility o f A g iv en B , P (A j B ), sa tisfy,
P (A \ B ) = P (A j B ) ¢ P (B ). T h u s,

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 GENERAL  ARTICLE

p (x 1 ;x 2 ;¢¢¢;x n )
= p (x n j x 1 ;x 2 ;¢¢¢;x n ¡1 )p (x 1 ;x 2 ;¢¢¢;x n ¡ 1 ):
O n itera tio n w e h av e
n
p (x 1 ;x 2 ;¢¢¢;x n ) = ¦ i= 1 p (x i j x 1 ;x 2 ;¢¢¢;x i¡1 ); (6 )

w h ere p (x 1 j x 0 ) is in terp reted to m ea n p (x 1 j a ) = p (x 1 )

sin ce p (a ) = 1 . N ow , fro m (5 ), w e see th a t p (x i j
x 1 ;x 2 ;¢¢¢;x i¡ 1 ) is a ra tio o f tw o p o sitiv e in teg ers b e-
tw een 1 a n d N , so th a t
1
p (x i j x 1 ;x 2 ;¢¢¢;x i¡1 ) ¸ :
N
H en ce fro m (6 ),
µ ¶n
1
p (x 1 ;x 2 ;¢¢¢;x n ) ¸ :
N

L et A n d en o te th e set o f p a th s (x 1 ;x 2 ;¢¢¢;x n ) w ith x n =

0 o r x n = N , a n d let B n = rem a in in g set o f p a th s,
n a m ely th o se p a th s (x 1 ;x 2 ;¢¢¢;x n ) o f len g th n fo r w h ich
0 < x n < N . N o te th a t fo r a p a th (x 1 ;x 2 ;¢¢¢;x n ) in B n ,
0 < x i < N , fo r a ll i;1 · i · n .
T h ere is a n o n -in crea sin g p a th a ¸ x 1 ¸ x 2 ¸ x 3 ¸
¢¢¢ ¸ x n ¸ ¢¢¢ w h erein th ere a re strict in eq u a lities u n til
a n x i is 0 , a fter w h ich th ey a re a ll eq u a lities. M o reov er,
th e ¯ rst i fo r w h ich x i = 0 is a t m o st eq u a l to a < N .
T h ere is a n o n -d ecrea sin g p a th a · x 1 · x 2 · x 3 ·
¢¢¢ · x n · ¢¢¢ w h erein th ere a re strict in eq u a lities u n til
a n x i is N , a fter w h ich th ey a re a ll eq u a lities. M o reov er,
th e ¯ rst i fo r w h ich x i = N is a t m o st eq u a l to N ¡ a <
N . S o th e p ro b a b ility o f th e set o f p a th s (x 1 ;x 2 ;¢¢¢;x N )
³ ´N
1
w ith x N = 0 o r N is > 2 N
, i.e.,
µ ¶N
1
p (A N )> 2 ;
N

RESONANCE  January 2009 73

 GENERAL  ARTICLE

w h en ce µ ¶N
1
p (B N )< 1¡ 2 :
N

C o n sid er n ow a p a th (x 1 ;x 2 ;¢¢¢;x N ), o f len g th N , w ith

0 < x N < N . T h en th e p ro b a b ility o f th e set o f p a th s
sta rtin g a t x N a t tim e N a n d n o t h ittin g 0 o r N ³d u rin
´N
g
1
tim e p o in ts (N + 1 ;N + 2 ;¢¢¢;2 N ) is a g a in < 1 ¡ 2 N :
T h is im p lies th a t
µ ¶N
1
p (B 2N jB N )< 1¡ 2 :
N
W e see th erefo re th a t
à µ ¶N !2
1
p (B 2N ) = p (B 2N jB N ) ¢ p (B N )< 1¡ 2 :
N

In g en era l w e h av e,
à µ ¶N !k
1
p (B kN )< 1¡ 2 ; k = 1 ;2 ;¢¢¢:
N

H en ce
p (B kN ) ! 0 as n ! 1 :
In a d d itio n , p (B n ) is n o n -in crea sin g in n , h en ce p (B n ) !
0 as n ! 1 .
T h is im p lies th a t
0 1
\
p@ B n A = limn p (B n ) = 0 :
n ¸1

B ut \
B ´ B N
n ¸1

is th e ev en t th a t th e g a m b lin g d o es n o t term in a te in
¯ n ite tim e. T h u s, w e h av e p rov ed th e ¯ rst p a rt o f:

74 RESONANCE  January 2009

 GENERAL  ARTICLE

T h e o re m 3 .1 (i) T he probability of the set of an in -

vestor's paths w hich hit 0 or N at som e ¯ n ite tim e is
on e, so that w ith probability on e the in vestor w ill, in ¯ -
n ite am ou n t of tim e, either go ban kru pt or reach her goal
N .
(ii) T he probability that the in vestor reaches N in ¯ n ite
tim e is Na , an d the probability that she reaches 0 in ¯ n ite
tim e is 1 ¡ Na .
N ex t w e p rov e (ii). L et u s b e m o re m a th em a tica l. W rite
X n fo r th e a m o u n t th e in v esto r receiv es o r h a s a t tim e
n . G iv en X 1 = x 1 ;X 2 = x 2 ;¢¢¢;X n ¡1 = x n ¡ 1 , w e k n ow
th a t X n a ssu m es a t m o st tw o va lu es a n d th e p ro b a b il-
ities w ith w h ich th ese va lu es a re a ssu m ed sa tisfy th e
m a rtin g a le co n d itio n (4 ) w ith n rep la ced b y n ¡ 1 . W e
n ow w rite th is a s a co n d itio n a l ex p ecta tio n :
E (X n jX 1 = x 1 ;X 2 = x 2 ;¢¢¢;X n ¡1 = x n ¡1 ) = x n ¡ 1 :

W e a b b rev ia te E (X n j X 1 = x 1 ;X 2 = x 2 ;¢¢¢;X n ¡ 1 =
x n ¡1 ) a s E (X n j x 1 ;x 2 ;¢¢¢;x n ¡ 1 ). W ritin g E (X ) fo r th e
ex p ected va lu e o f a ra n d o m va ria b le X , w e see th a t
X
E (X n ) = E (X n j x 1 ;x 2 ;¢¢¢;x n ¡ 1 )p (x 1 ;x 2 ;¢¢¢;x n ¡1 )
C
X
= x n ¡ 1 p (x 1 ;x 2 ;¢¢¢;x n ¡1 )
C
X
= x n ¡1 p (X n ¡1 = x n ¡ 1 ) = E (X n ¡1 )
x n ¡ 1 2D

w h ere C is th e set o f in v esto r p a th s u p to tim e n ¡ 1 ,

w h ile D is th e ra n g e o f ra n d o m v a ria b le X n ¡1 . W e th u s
h av e
E (X n ) = E (X n ¡1 ) = ¢¢¢ = E (X 1 ) = a : (7 )

W e h av e seen in (i) th a t lim n ! 1 X n = X 1 ex ists w ith

p ro b a b ility o n e a n d X 1 a ssu m es o n ly tw o va lu es 0 a n d
N . A lso

jE X n ¡ E X 1 j· E j X n ¡ X 1 j· 2 N P (B n ):

RESONANCE  January 2009 75

 GENERAL  ARTICLE

B y th e ¯ rst p a rt o f th e th eo rem , P (B n ) ! 0 a s n ! 1 ,
a n d sin ce, b y (7 ), E (X n ) = a fo r a ll n , w e see th a t

E (X 1 ) = a:

If s a n d t d en o te th e p ro b a b ilities w ith w h ich X 1 a s-

su m es va lu es 0 a n d N resp ectiv ely, th en w e h av e

E (X 1 ) = 0 ¢s + t ¢N = a;

so th a t
a a
t = p (X 1 = N )= ;s = p (X 1 = 0) = 1 ¡ :
N N
T h is p ro v es th e seco n d p a rt a n d co m p letes th e p ro o f o f
th e th eo rem .
A rea d er fa m ilia r w ith a d va n ced p ro b a b ility w ill n o te
th a t th e a b ov e th eo rem fo llow s fro m D o o b 's M a rtin g a le
co n v erg en ce th eo rem , sin ce th e p ro cess X n ;n = 1 ;2 ;¢¢¢
is a u n ifo rm ly b o u n d ed m a rtin g a le (see [1 ], [3 ]).
T h u s o u r m o d el o f a n in v esto r's w a lk , th o u g h h y p o th eti-
ca l, a n d d o es n o t ta k e in to co n sid era tio n th e co m p lex ity
o f th e m a rk et, d o es co n ¯ rm th e p ra ctica l a d v ice th a t
h o n est in v estm en t a d v isers g iv e to th e m id d le cla ss in -
v esto rs in In d ia :
\ If y o u d o n o t h av e m u ch m o n ey a n d y o u r liv elih o o d d e-
p en d s o n w h a t y o u ea rn o n y o u r sav in g s, o r y o u r m a rg in
o f sav in g is sm a ll, th en b e ca refu l, b u t if y o u r liv elih o o d
is ta k en ca re o f, a n d ¯ n a n cia lly y o u a re su ± cien tly se-
cu re, th en it is a g o o d id ea to ta k e ch a n ces w ith m u tu a l
fu n d s, a n d p o ssib ly ea rn a la rg er retu rn ."
A sp ecia l ca se o f in v esto r's w a lk , n a m ely, sy m m etric ra n -
d o m w a lk w ith a b so rb in g b a rriers, is a lrea d y d iscu ssed
in S ectio n 2 a b ov e, a n d its im p lica tio n fo r a g a m b ler is
w ell d iscu ssed in th e p ro b a b ility litera tu re, ev en w h en
th e p ro b a b ilities a re n o t sy m m etric (see [2 ], C h a p ter

76 RESONANCE  January 2009

 GENERAL  ARTICLE

X IV ). O u r m o d el a b ov e, th o u g h b a sed o n a m a rtin g a le A greedy investor,

b u ild in g b lo ck , is m u ch m o re g en era l th a n th e sim p le no matter how rich,
sy m m etric ra n d o m w a lk , a n d lea d s to th e sa m e co n clu -
will hit the bottom
sio n s in so fa r a s th e in v esto r is co n cern ed . S in ce th e
in the long run.
tra n sitio n p ro b a b ilities a t ea ch sta g e a re co m p letely a r-
b itra ry (b u t fo r th e m a rtin g a le req u irem en t), th ey n eed
n o t b e M a rk ov ia n ; so th e in v esto r's w a lk w e h av e d is-
cu ssed is n o t a ra n d o m w a lk in th e strict sen se o f th e
term . H en ce w e ca ll it a M artin gale w alk.
It is im p o rta n t to n o te th a t th e p ro b a b ility Na o f rea ch in g
N d ep en d s o n ly o n a a n d n o t o n w h a t stra teg y (b o ld o r
co n serva tiv e) th e in v esto r a d op ts.
If th e in v esto r is g reed y a n d n o t co n ten ted w ith receiv -
in g th e a m o u n t N , a n d ex ecu tes h er m a rtin g a le w a lk
w ith o u t a n a b so rb in g b a rrier a t th e u p p er en d , th en sh e
w ill ev en tu a lly h it zero w ith p ro b a b ility o n e, n o m a tter
h ow rich sh e is to b eg in w ith . T o see th is w e n o te th a t
p (X 1 = 0 ) = 1 ¡ Na ! 1 a s N ! 1 n o m a tter w h a t
th e sta rtin g ca p ita l a .
4 . Im p lic a tio n s fo r th e P o p u la tio n a s a W h o le
S o fa r w e h av e d iscu ssed th e im p lica tio n s o f o u r co n -
clu sio n s fo r a n in d iv id u a l in v esto r, lo ca lly, a s th ey say
in m a th em a tics. A re th ere im p lica tio n s g lo b a lly, o r fo r
so ciety a t la rg e? S u rely th ere a re. A co n sta n t refra in o f
sen sitiv e a n d o b serva n t in d iv id u a ls, w h eth er in In d ia o r
in a n a d va n ced w estern co u n try, is th a t \rich are get-
tin g richer an d poor are gettin g poorer" (see [4 ],[5 ],[6 ]).
T h ese in d iv id u a ls a re n o t n ecessa rily left-lea n in g , a n d
th ese a re n o t v iew s ex p ressed ou t o f id eo lo g ica l co n sid er-
a tio n s, b u t ra th er o u t o f co n cern fo r w h a t th ey see. C a n
o n e ju stify th ese v iew s, esp ecia lly w h en o n e sees a n in -
d iv id u a l p o o r p erso n d o in g w ell b y sh eer h a rd w o rk , a n d
a w ell-to -d o p erso n g ettin g p o o r? It seem s w e ca n . F o r
th e refra in `rich gettin g richer an d poor gettin g poorer'
is o n ly a n im p erfect a rticu la tio n o f a n o b v io u s sta tisti-

RESONANCE  January 2009 77


Law of Large Numbers
Ifyou do not knowthe prob-
ability of ‘heads’ with a
given coin then a reason-
able thing to do is to toss it
a large number n of times
and look at the proportion
of heads that you get as an
estimate of p. The law of
large numbers provides the
justification for this by as-
serting that if the tosses are
independent then this pro-
portion converges to p with
probability one as n goes to
infinity. A more general
version of this law is the
basis for modern statistical
inference.
Indeed, we see that
the collective
invested wealth of
the investors does
not change much,
but gets redistributed
more lopsidedly.
78
GENERAL  ARTICLE
ca l co n seq u en ce o f T h eo rem 3 .1 to g eth er w ith th e law of
large n u m bers. (It say s th a t if a n ex p erim en t resu lts in
o n e o f tw o p o ssib le o u tco m es, say su ccess S o r fa ilu re F
w ith p ro b a b ilities p a n d (1 ¡ p ) resp ectiv ely a n d if th e
ex p erim en t is rep ea ted in d ep en d en tly n tim es a n d p n is
th e p ro p o rtio n o f su ccesses in th ese n rep etitio n s, th en
p n g ets clo se to p w ith h ig h p rob a b ility th a t g o es to o n e
a s n g o es to in ¯ n ity.) In d eed , w e see th a t th e co llectiv e
in v ested w ea lth o f th e in v esto rs d o es n o t ch a n g e m u ch ,
b u t o n ly g ets red istrib u ted m ore lo p sid ed ly.
Im a g in e th a t th e m a rk et h a s 2 0 0 in v esto rs, 1 0 0 o f th em
w ell to d o a n d th e rem a in in g h u n d red n o t so w ell to d o .
A ssu m e th a t th e m a x im u m p o ssib le receiva b le a m o u n t
is 1 0 u n its, i.e., N = 1 0 : (A u n it co u ld b e th o u sa n d ,
1 0 th o u sa n d , 1 0 0 th o u sa n d , o r a m illio n o r m o re.) A s-
su m e th a t ea ch o f th e w ell to d o in v esto r in v ests 7 u n its,
w h ile th o se n o t so w ell to d o in v est 3 u n its ea ch . (W e
w ill a ssu m e th a t th e `fa ir g a m e' co n d itio n h o ld s a n d th e
p ro cess (X n )1n = 1 o f in v esto r's ea rn in g s is a M a rtin g a le.)
A cco rd in g to o u r th eo rem , th e p ro b a b ility o f a w ell to
d o in v esto r rea ch in g 1 0 u n its in th e lo n g ru n is 170 , a n d
th e p ro b a b ility th a t a w ell to d o in v esto r h its 0 is 130 : A s-
su m e th a t th e in v esto rs a ct in d ep en d en tly. L et W 1 a n d
L 1 b e th e n u m b er o f w in n ers an d lo sers a m o n g th e w ell
to d o in v esto rs. T h en b y th e law o f la rg e n u m b ers W 1
is a p p rox im a tely 7 0 , a n d th ey w ill rea ch 1 0 , w h ile L 1 is
a p p rox im a tely 3 0 , a n d th ey w ill h it 0 . In co n tra st, if W 2
a n d L 2 a re th e n u m b er o f w in n ers a n d lo sers a m o n g th e
n o t so w ell to d o in v esto rs, th en L 2 = a p p rox im a tely
7 0 , th ey w ill h it 0 , a n d , W 2 = a p p rox im a tely 3 0 , a n d
th ey w ill h it 1 0 . T h u s o rig in a lly th ere w ere n o p a u p ers
a m o n g th e in v esto rs, n ow th ere a re n ea rly 1 0 0 p a u p ers
a m o n g th em , n ea rly 7 0 o f th em a re th o se w h o w ere n o t
w ell to d o to b eg in w ith . N ea rly 3 0 a m o n g th em a re p re-
v io u sly w ell to d o in v esto rs. A lso th ere a re n ow n ea rly
1 0 0 v ery w ell to d o a n d co n ten ted in v esto rs, n ea rly 3 0
a m o n g th em w ere n o t so w ell to d o in th e b eg in n in g . W e
RESONANCE  January 2009
 GENERAL  ARTICLE

a lso n o te th a t th e to ta l a m o u n t in v estm en t o f a t tim e

zero is 7 £ 1 0 0 + 3 £ 1 0 0 = 1 0 0 0 w h ich rem a in s n ea rly th e
sa m e sin ce a cco rd in g to th e n ew d istrib u tio n o f ea rn ed
o r lo st w ea lth th e to ta l w ea lth rem a in s a p p rox im a tely
10 £ 100 + 0 £ 100 = 1000. Address for Correspondence
K B Athreya
O n e ca n re¯ n e th ese a ssertio n s fu rth er b y u sin g w h a t is Department of Mathematics
k n ow n a s th e cen tra l lim it th eo rem (see [3 ]). Iowa State University,
Ames, Iowa
R e m a r k . T h e q u estio n w h eth er th e g a m b ler a n d th e Email: kba@iastate.edu
in v esto r in th is a rticle sh o u ld b e m a le o r fem a le w a s and
d ecid ed b y to ssin g a co in . I M I, Department of Math-
ematics,
Indian Institute of Science,
Suggested Reading Bangalore, 560012, India.
Email:kba@math.iisc.ernet.in
[1] J L Doob, Stochastic Processes, John Wiley, New York, 1953.
[2] William Feller, An Introduction to Probability Theory and Its Applica- M G Nadkarni
tions, Wiley Eastern Edition, New Delhi, Vol. 1, 1968. Department of Mathematics,
[3] K B Athreya and S N Lahiri, Probability Theory, TRIM Series, Vol.41, University of Mumbai
Hindustan Book Agency, New Delhi, 2007. Kalina, Mumbai, 400098,
[4] google: growing disparity. India.
[5] google: rich getting richer, poor getting poorer. Email:
[6] Sudhindra Kulkarni, Muktachintan, Loksatta, Mumbai Edition, Sept. mgnadkarni@gmail.com
23, p.4, 2007.

RESONANCE  January 2009 79