Dutch Book Arguments

From Logic

In gambling a Dutch book or lock is a set of odds and bets which guarantees a profit, regardless of the outcome of the gamble. It is associated with probabilities implied by the odds not being coherent. In a thought experiment proposed by the Italian probabilist Bruno de Finetti in order to justify Bayesian probability, an array of wagers is coherent precisely if it does not expose the wagerer to certain loss regardless of the outcomes of events on which he is wagering, provided his opponent chooses judiciously.


Operational subjective probabilities as wagering odds

You must set the price of a promise to pay $1 if John Smith wins tomorrow's election, and $0 otherwise. You know that your opponent will be able to choose either to buy such a promise from you at the price you have set, or require you to buy such a promise from him/her, still at the same price. In other words: you set the odds, but your opponent decides which side of the bet will be yours. The price you set is the "operational subjective probability" that you assign to the proposition on which you are betting.

"Dutch books"

A very trivial Dutch book

The rules do not forbid you to set a price higher than $1, but if you do, your prudent opponent may sell you that high-priced ticket, and then your opponent comes out ahead regardless of the outcome of the event on which you bet. Neither are you forbidden to set a negative price, but then your opponent may make you pay him to accept a promise from you to pay him later if a certain contingency eventuates. Either way, you lose. These lose-lose situations parallel the fact that a probability can neither exceed 1 nor be less than 0.

A somewhat less trivial and more instructive Dutch book

Now suppose you set the price of a promise to pay $1 if the Boston Red Sox win next year's World Series, and also the price of a promise to pay $1 if the New York Yankees win, and finally the price of a promise to pay $1 if either the Red Sox or the Yankees win. You may set the prices in such a way that

Failed to parse (Can't write to or create math temp directory): {\\mbox{Price}(\\mbox{Red}\\ \\mbox{Sox})+\\mbox{Price}(\\mbox{Yankees})\ eq\\mbox{Price}(\\mbox{Red}\\ \\mbox{Sox}\\ \\mbox{or}\\ \\mbox{Yankees})}

But if you set the price of the third ticket too low, your prudent opponent will buy that ticket and sell you the other two tickets. By considering the three possible outcomes (Red Sox, Yankees, some other team), you will see that regardless of which of the three outcomes eventuates, you lose. An analogous fate awaits you if you set the price of the third ticket too high relative to the other two prices. This parallels the fact that probabilities of mutually exclusive events are additive (see probability axioms).

A person who has set prices on an array of wagers in such a way that he or she will suffer a net loss regardless of which outcome eventuates is said to have made a Dutch book.

See also:


Personal tools