Lit Dragon fire arrows are used during the Underground Pass quest. They are created by using a damp cloth on regular dragon arrows to create unlit dragon fire arrows, which are then lit by using them on a fire. Any lit fire arrow can be used to pierce the rope in the Underground Pass Dungeon, which lowers a bridge. This is necessary to complete the quest. Any type of fire arrow will have the same effect in the quest, so it is recommended to use a cheaper arrow, such as a bronze fire arrow.
Dragon fire arrows have the same Ranged Strength bonus as regular dragon arrows, and the fire provides no additional benefit.