Interview Question: From Gambling Parlors to Wall Street

Sample Question #104 (probability theory – stochastics)

What’s the definition of a Martingale? Why is it an important concept in quantitative finance?

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One Response to Interview Question: From Gambling Parlors to Wall Street

  1. Brett says:

    ANSWER
     
    A Martingale refers to a time series process, continuous or discrete, that satisfies two conditions:
     
    1) the distribution has a finite mean;
    2) given all values up to some time t, the conditional expectation of values beyond t is just the value at t (the keyword is "conditional")
     
    It’s important because in finance we cannot forecast anything, so we might as well assume every time series is a Martingale. Option pricing is based largely on Martingale theories.

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