Central limit theorem : game of chance

central limit theoremprobabilityprobability theory

We consider the following game of chance with independent rounds:

In each round we can win ten euros with probability $0.1$, we can lose one euro with probability $0.7$ and two euros with probability $0.2$. A bet of 50 cents must be paid per round.

Calculate approximately the probability using the central limit theorem for the fact that the profit (= income – outcome) after 100 played rounds is at most five euros. Explain.

From the central limit theorem we have that $$P\left (Z_{100}\leq 5 \right )=\frac{1}{\sqrt{2\pi}}\int_{-\infty}^5e^{-x^2/2}\, dx$$ with $Z_{100}=\sqrt{n}\left (\frac{\overline{X}_{100}-\mu}{\sigma}\right )$ or not?

Best Answer

We'll call $X_i$ profit from round $i$, which has moments $$E[X_i]=-0.5+10(0.1)-1(0.7)-2(0.2)=:\mu\\ \text{Var}(X_i)=E[X_i^2]-(E[X_i])^2=10^2(0.1)+(-1)^2(0.7)+(-2)^2(0.2)-\mu^2=:\sigma^2.$$

Since the $X_i$ are independent, CLT tells us $$ \frac{\frac{1}{n}\sum_{i=1}^n X_i -\mu}{\sigma/\sqrt n}\overset{d}{\rightarrow}N(0,1),$$

which gives an asymptotic approximation for the probability that the profit after 100 rounds is $\leq5$:

$$P\left(\sum_{i=1}^{100} X_i\leq 5\right)=P\left(\frac{\frac{1}{100}\sum_{i=1}^{100} X_i -\mu}{\sigma/\sqrt {100}}\leq \frac{\frac{5}{100}-\mu}{\sigma/\sqrt {100}}\right)\approx \Phi \left(\frac{\frac{5}{100}-\mu}{\sigma/\sqrt {100}}\right)=\Phi \left(\frac{0.5-10\mu}{\sigma}\right),$$ where $\Phi$ is the CDF of a standard normal.

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