Risk is random: The magic of the d'Alembert

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Abstract

The most common bets in 19th-century casinos were even-money bets on red or black in Roulette or Trente et Quarante. Many casino gamblers allowed themselves to be persuaded that they could make money for sure in these games by following betting systems such as the d'Alembert. What made these systems so seductive? Part of the answer is that some of the systems, including the d'Alembert, can give bettors a very high probability of winning a small or moderate amount. But there is also a more subtle aspect of the seduction. When the systems do win, their return on investment --- the gain relative to the amount of money the bettor has to take out of their pocket and put on the table to cover their bets --- can be astonishingly high. Systems such as le tiers et le tout, which offer a large gain when they do win rather than a high probability of winning, also typically have a high upside return on investment. In order to understand these high returns on investment, we need to recognize that the denominator --- the amount invested --- is random, as it depends on how successive bets come out.

In this article, we compare some systems on their return on investment and their success in hiding their pitfalls. Systems that provide a moderate gain with a very high probability seem to accomplish this by stopping when they are ahead and more generally by betting less when they are ahead or at least have just won, while betting more when they are behind or have just lost. For historical reasons, we call this martingaling. Among martingales, the d'Alembert seems especially good at making an impressive return on investment quickly, encouraging gamblers' hope that they can use it so gingerly as to avoid the possible large losses, and this may explain why its popularity was so durable.

We also discuss the lessons that this aspect of gambling can have for evaluating success in business and finance and for evaluating the results of statistical testing.

Versions

➤  Version 1 (2020-08-23)

Citation

Harry Crane and Glenn Shafer (2020). Risk is random: The magic of the d'Alembert. Researchers.One, https://researchers.one/articles/risk-is-random-the-magic-of-the-d-alembert/5f52699d36a3e45f17ae7ea4/v1.

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