Martingale (probability theory)

In full generality, a stochastic process ${\displaystyle Y:T\times \Omega \to S}$ taking values in a Banach space ${\displaystyle S}$ with norm ${\displaystyle \lVert \cdot \rVert _{S}}$ is a martingale with respect to a filtration ${\displaystyle \Sigma _{*}}$ and probability measure ${\displaystyle \mathbb {P} }$ if

• Σ_∗ is a filtration of the underlying probability space (Ω, Σ, ${\displaystyle \mathbb {P} }$);
• Y is adapted to the filtration Σ_∗, i.e., for each t in the index set T, the random variable Y_t is a Σ_t-measurable function;
• for each t, Y_t lies in the L^p space L¹(Ω, Σ_t, ${\displaystyle \mathbb {P} }$; S), i.e.

${\displaystyle \mathbf {E} _{\mathbb {P} }(\lVert Y_{t}\rVert _{S})<+\infty ;}$

• for all s and t with s < t and all F ∈ Σ_s,

${\displaystyle \mathbf {E} _{\mathbb {P} }\left([Y_{t}-Y_{s}]\chi _{F}\right)=0,}$

where χ_F denotes the indicator function of the event F. In Grimmett and Stirzaker's Probability and Random Processes, this last condition is denoted as

${\displaystyle Y_{s}=\mathbf {E} _{\mathbb {P} }(Y_{t}\mid \Sigma _{s}),}$

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

In the Banach space setting the conditional expectation is also denoted in operator notation as ${\displaystyle \mathbf {E} ^{\Sigma _{s}}Y_{t}}$.^[4]

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. To be more specific: 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 it comes up tails. The gambler's conditional expected fortune after the next trial, given the history, is equal to their present fortune. This sequence is thus a martingale.
• Let Y_n = X_n² − 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 the coin is unfair, i.e., biased, with probability p of coming up heads and probability q = 1 − p of tails. Let

${\displaystyle X_{n+1}=X_{n}\pm 1}$

with "+" in case of "heads" and "−" in case of "tails". Let

${\displaystyle Y_{n}=(q/p)^{X_{n}}.}$

Then { Y_n : n = 1, 2, 3, ... } is a martingale with respect to { X_n : n = 1, 2, 3, ... }. To show this

${\displaystyle {\begin{aligned}E[Y_{n+1}\mid X_{1},\dots ,X_{n}]&=p(q/p)^{X_{n}+1}+q(q/p)^{X_{n}-1}\\[6pt]&=p(q/p)(q/p)^{X_{n}}+q(p/q)(q/p)^{X_{n}}\\[6pt]&=q(q/p)^{X_{n}}+p(q/p)^{X_{n}}=(q/p)^{X_{n}}=Y_{n}.\end{aligned}}}$

• Pólya's urn contains a number of different-coloured marbles; at each iteration
  a marble is randomly selected from the urn and replaced with several more of that same colour. For any given colour, the fraction of marbles in the urn with that colour is a martingale. For example, if currently 95% of the marbles are red then, though the next iteration is more likely to add red marbles than another color, this bias is exactly balanced out by the fact that adding more red marbles alters the fraction much less significantly than adding the same number of non-red marbles would.
• (
  random sample
  X₁, ..., X_n is taken. Let Y_n be the "likelihood ratio"

• 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 λ, then the compensated Poisson process { N_t − λt : t ≥ 0 } is a continuous-time martingale with right-continuous/left-limit
  sample paths

• Wald's martingale

• A ${\displaystyle d}$-dimensional process ${\displaystyle M=(M^{(1)},\dots ,M^{(d)})}$ in some space ${\displaystyle S^{d}}$ is a martingale in ${\displaystyle S^{d}}$ if each component ${\displaystyle T_{i}(M)=M^{(i)}}$ is a one-dimensional martingale in ${\displaystyle S}$.

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 | X₁,...,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_τ : τ ≤ s}] − X_s = 0 ∀s ≤ t, a harmonic function f satisfies the partial differential equation Δf = 0 where Δ 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 ${\displaystyle X_{1},X_{2},X_{3},\ldots }$ of
  integrable
  random variables satisfying

${\displaystyle \operatorname {E} [X_{n+1}\mid X_{1},\ldots ,X_{n}]\geq X_{n}.}$

Likewise, a continuous-time submartingale satisfies

${\displaystyle \operatorname {E} [X_{t}\mid \{X_{\tau }:\tau \leq s\}]\geq X_{s}\quad \forall s\leq t.}$

In potential theory, a subharmonic function f satisfies Δf ≥ 0. Any subharmonic function that is bounded above by a harmonic function for all points on the boundary of a ball is 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 | X₁,...,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

${\displaystyle \operatorname {E} [X_{n+1}\mid X_{1},\ldots ,X_{n}]\leq X_{n}.}$

Likewise, a continuous-time supermartingale satisfies

${\displaystyle \operatorname {E} [X_{t}\mid \{X_{\tau }:\tau \leq s\}]\leq X_{s}\quad \forall s\leq t.}$

In potential theory, a

superharmonic function

f satisfies Δf ≤ 0. Any superharmonic function that is bounded below by a harmonic function for all points on the boundary of a ball is 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 | X₁,...,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_n² − n is a martingale). Similarly, a concave function of a martingale is a supermartingale.

Martingales and stopping times

A stopping time with respect to a sequence of random variables X₁, X₂, X₃, ... is a random variable τ with the property that for each t, the occurrence or non-occurrence of the event τ = t depends only on the values of X₁, X₂, X₃, ..., 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 their 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 τ = t is

One of the basic properties of martingales is that, if ${\displaystyle (X_{t})_{t>0}}$ is a (sub-/super-) martingale and ${\displaystyle \tau }$ is a stopping time, then the corresponding stopped process ${\displaystyle (X_{t}^{\tau })_{t>0}}$ defined by ${\displaystyle X_{t}^{\tau }:=X_{\min\{\tau ,t\}}}$ 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

Notes