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I have come into one problem that I don't know the solution of.

Let's suppose there is a casino, where you can bet on toin coss, and you get the double if you bet right. Let's also suppose that the casino always has money to pay to everyone.

It is a fair coin, so the gamblers have 50% chance to be right.

Now, imagine that all the gamblers always bet everything they have and what they have won already. In every bet. New gamblers enter the casino time from time. Gamblers do have finite amount of money.

The gamblers have high probability of losing everything, very soon. So, most of the gamblers will come out empty-handed after a while.

However, from the casino's point of view, they have zero expected income, because you do have zero expected income at this type of game.

So, the players lose everything, while the casino shouldn't have any income.

How is that possible?

edit: There was a question if casino has infinite amount of money. I am not sure about that, actually. Does it change the problem? If it does, how?

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Can you please tell me the odds of being correct? Are assuming the casino has infinite amount of money? are we assuming all the players have infinite amount of money? Also, if you only had 10% of being correct on each bet, the casino wouldn't have zero expected income. –  simplicity Nov 27 '11 at 1:14
    
I clarified it. It is a fair coin and they have 50% chance of being right. –  Karel Bílek Nov 27 '11 at 1:16
    
I don't see the problem here. Also we assuming the casino has infinite amount of money and there are infinite amount of people playing it? –  simplicity Nov 27 '11 at 1:23
    
There is a finite number of people playing it at a given time. Casino ... I am not sure about that. OK, yes, suppose it has infinite amount of money. –  Karel Bílek Nov 27 '11 at 1:29
    
My "problem" is - the people are in loss, but the casino shouldn't be in gain. –  Karel Bílek Nov 27 '11 at 1:35
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2 Answers

up vote 4 down vote accepted

The casino only has zero expected income at every finite time step, because at every stage there is a small chance that one of the gamblers has won an exponentially large amount of money.

However, if there are a finite number of gamblers, then after some finite time they will all have run out of money, and the casino will be in profit. But a priori you don't know when this time is, so there is always a zero expectation for the casino.

A nice way to see this is by looking at some random realizations. I wrote a quick Matlab script to simulate this situation. I took 1024 gamblers who each came into the casino with a dollar, and ran the simulation for 20 time steps (so that there's only a very small probability that any of the gamblers have any money remaining by the 20th step). I then repeated this 100 times, and plotted the casino's net gain/loss after each time step for each of the 100 runs.

casino

As you can see, although all the casinos end up in profit, some of them suffer extreme losses before they enter profitability. It is this possibility for extreme loss that means that they always have zero expectation of profit.

Note that I had to truncate the bottom of the plot for this to be anything other than a mess of blue lines - the worst-performing casino in my sample incurred losses of $65,000 before returning to profitability!


Here's another way to look at it. After $t$ timesteps, the total player winnings are

$$\sum_{i=1}^n X_i$$

where each $X_i$ is a random variable taking the values $2^t$ with probability $2^{-t}$ or $0$ with probability $1-2^{-t}$.

For each player, their expected winnings at time $t$ is 1, but the variance of their winnings is $2^t-1$. Therefore the variance of the total winnings for $n$ players is $n(2^t-1)$. And the variance of casino winnings is the same, by symmetry.

This explains why the result is so unintuitive - for most problems, the variance stabilises as the number of timesteps increases. For this problem the variance keeps increasing, so talking about the limit of infinitely many timesteps doesn't make a lot of sense.

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Extremely helpful answer, thanks! –  Karel Bílek Nov 27 '11 at 2:13
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There is a possibility that one of the gamblers will keep winning forever and become infinitely rich. The probability of this happening is $0$, but since the loss to the casino in this case is infinite, it is not clear that it is sound simply to disregard it.

In particular, it is not clear that we can validly use expected values to analyze the casino's long-term position here -- the situation is somewhat reminiscent of the St. Petersburg paradox. See also Gambler's ruin.

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