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Optional stopping theorem

In probability theory, optional stopping theorem (or

Doobs optional sampling theorem) says that, under
certain conditions, the expected value of a martingale at
a stopping time is equal to the expected value of its initial value. Since martingales can be used to model the
wealth of a gambler participating in a fair game, the optional stopping theorem says that on the average nothing
can be gained by stopping to play the game based on the
information obtainable so far (i.e., by not looking into the
future). Of course, certain conditions are necessary for
this result to hold true, in particular doubling strategies
have to be excluded.

E[X ] E[X0 ],
for a supermartingale.

1.1 Remark
Under condition (c) it is possible that = happens with
positive probability. On this event X is dened as the
almost surely existing pointwise limit of X, see the proof
below for details.

The optional stopping theorem is an important tool of

mathematical nance in the context of the fundamental
theorem of asset pricing.

2 Applications
The optional stopping theorem can be used to prove
the impossibility of successful betting strategies for
a gambler with a nite lifetime (which gives condition (a)) and a house limit on bets (condition (b)).
Suppose that the gambler can wager up to c dollars
on a fair coin ip at times 1, 2, 3, etc., winning his
wager if the coin comes up heads and losing it if
the coin comes up tails. Suppose further that he can
quit whenever he likes, but cannot predict the outcome of gambles that haven't happened yet. Then
the gamblers fortune over time is a martingale, and
the time at which he decides to quit (or goes broke
and is forced to quit) is a stopping time. So the theorem says that E[X] = E[X0 ]. In other words, the
gambler leaves with the same amount of money on
average as when he started. (The same result holds
if the gambler, instead of having a house limit on
individual bets, has a nite limit on his line of credit
or how far in debt he may go, though this is easier to
show with another version of the theorem.)[1]

Statement of theorem

A discrete-time version of the theorem is given below:

Let X = (Xt)t0 be a discrete-time martingale and a
stopping time with values in 0 {}, both with respect
to a ltration (Ft)t0 . Assume that one of the following
three conditions holds:
(a) The stopping time is almost surely
bounded, i.e., there exists a constant c such
that c a.s.
(b) The stopping time has nite expectation
and the conditional expectations of the absolute
value of the martingale increments are almost
surely bounded, more precisely, E[ ][< and
there exists
] a constant c such that E |Xt+1
Xt | Ft c almost surely on the event { >
t} for all t 0 .
(c) There exists a constant c such that |Xt|
c a.s. for all t 0 .

Suppose a random walk starting at a 0 that goes up

or down by one with equal probability on each step.
Suppose further that the walk stops if it reaches 0 or
m a; the time at which this rst occurs is a stopping
time. If it is known that the expected time at which
the walk ends is nite (say, from Markov chain theory), the optional stopping theorem predicts that the
expected stop position is equal to the initial position
a. Solving a = pm + (1 p)0 for the probability p
that the walk reaches m before 0 gives p = a/m.

Then X is an almost surely well dened random variable

and E[X ] = E[X0 ].
Similarly, if the stochastic process X is a submartingale or
a supermartingale and one of the above conditions holds,

E[X ] E[X0 ],

Now consider a random walk X that starts at 0 and

stops if it reaches m or +m, and use the Yn = Xn2

for a submartingale, and


n martingale from the examples section. If is the
time at which X rst reaches m, then 0 = E[Y 0 ] =
E[Y] = m2 E[]. This gives E[] = m2 .

E[M ] = E[|X0 |] +


[ [
E E |Xs+1 Xs | Fs 1{ >s}
c 1{ >s} (b) by a.s.

Care must be taken, however, to ensure that one of

the conditions of the theorem hold. For example,
suppose the last example had instead used a 'onesided' stopping time, so that stopping only occurred
at +m, not at m. The value of X at this stopping
time would therefore be m. Therefore, the expectation value E[X] must also be m, seemingly in violation of the theorem which would give E[X] = 0.
The failure of the optional stopping theorem shows
that all three conditions fail.

E[|X0 |] + c

P( > s)


= E[|X0 |] + c E[ ] < ,
where a representation of the expected value of nonnegative integer-valued random variables is used for the
last equality.
Therefore, under any one of the three conditions in the
theorem, the stopped process is dominated by an integrable random variable M. Since the stopped process X

converges almost surely to X , the dominated convergence theorem implies


E[X ] = lim E[Xt ].

Let X denote the stopped process, it is also a martingale (or a submartingale or supermartingale, respecBy the martingale property of the stopped process,
tively). Under condition (a) or (b), the random variable
X is well dened. Under condition (c) the stopped process X is bounded, hence by Doobs martingale conver
gence theorem it converges a.s. pointwise to a random E[Xt ] = E[X0 ], t N0 ,
variable which we call X.
If condition (c) holds, then the stopped process X is
bounded by the constant random variable M := c. Otherwise, writing the stopped process as
E[X ] = E[X0 ].

Xt = X0 +


(Xs+1 Xs ),

t N0 ,

Similarly, if X is a submartingale or supermartingale, respectively, change the equality in the last two formulas to
the appropriate inequality.


4 References

gives |Xt | M for all t 0 , where

M := |X0 |+

|Xs+1 Xs | = |X0 |+


[1] http://www.scribd.com/doc/28125042/

|Xs+1 Xs |1{ >s}


By the monotone convergence theorem

5 External links
Doobs Optional Stopping Theorem

E[M ] = E[|X0 |] +

E |Xs+1 Xs | 1{ >s}

If condition (a) holds, then this series only has a nite

number of non-zero terms, hence M is integrable.
If condition (b) holds, then we continue by inserting a
conditional expectation and using that the event { > s} is
known at time s (note that is assumed to be a stopping
time with respect to the ltration), hence

Text and image sources, contributors, and licenses



Optional stopping theorem Source: http://en.wikipedia.org/wiki/Optional%20stopping%20theorem?oldid=640609785 Contributors:

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