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This volume provides the definitive treatment of fortune's formula or the Kelly capital growth criterion as it is often called. The strategy is to maximize long run wealth of the investor by maximizing the period by period expected utility of wealth with a logarithmic utility function. Mathematical theorems show that only the log utility function maximizes asymptotic long run wealth and minimizes the expected time to arbitrary large goals. In general, the strategy is risky in the short term but as the number of bets increase, the Kelly bettor's wealth tends to be much larger than those with essentially different strategies. So most of the time, the Kelly bettor will have much more wealth than these other bettors but the Kelly strategy can lead to considerable losses a small percent of the time. There are ways to reduce this risk at the cost of lower expected final wealth using fractional Kelly strategies that blend the Kelly suggested wager with cash. The various classic reprinted papers and the new ones written specifically for this volume cover various aspects of the theory and practice of dynamic investing. Good and bad properties are discussed, as are fixed-mix and volatility induced growth strategies. The relationships with utility theory and the use of these ideas by great investors are featured.
- Sales Rank: #788521 in Books
- Published on: 2011-02-10
- Original language: English
- Number of items: 1
- Dimensions: 9.70" h x 2.00" w x 6.60" l, 3.25 pounds
- Binding: Paperback
- 884 pages
Most helpful customer reviews
89 of 94 people found the following review helpful.
Finally, a compendium of the most rigorous research (gamblers ruin based) on risky decisions
By N N Taleb
There are two methods to consider in a risky strategy.
1) The first is to know all parameters about the future and engage in optimized portfolio construction, a lunacy unless one has a god-like knowledge of the future. Let us call it Markowitz-style. In order to implement a full Markowitz- style optimization, one needs to know the entire joint probability distribution of all assets for the entire future, plus the exact utility function for wealth at all future times. And without errors! (I have shown that estimation errors make the system explode.)
2) Kelly's method (or, rather, Kelly-Thorpe), developed around the same period, which requires no joint distribution or utility function. It is very robust. In practice one needs to estimate the ratio of expected profit to worst- case return-- dynamically adjusted to avoid ruin. In the case of barbell transformations, the worst case is guaranteed (leave 80% or so of your money in reserves). And model error is much, much milder under Kelly criterion. So, assuming one has the edge (as a sole central piece of information), engage in a dynamic strategy of variable betting, getting more conservative after losses ("cut your losses") and more aggressive "with the house's money". The entire focus is the avoidance of gambler's ruin.
The first strategy was only embraced by academic financial economists --empty suits without skin in the game -- because you can make an academic career writing BS papers with method 1 much better than with method 2. On the other hand EVERY SURVIVING speculator uses explicitly or implicitly method 2 (evidence: Ray Dalio, Paul Tudor Jones, Renaissance, even Goldman Sachs!) For the first method, think of LTCM and the banking failure.
Let me repeat. Method 2 is much, much, much more scientific in the true sense of the word, that is rigorous and applicable. Method 1 is good for "job market papers" . Now this book presents all the major papers for the second line of thinking. It is almost exhaustive; many great thinkers in Information theory and probability (Ed Thorpe, Leo Breiman, T M Cover, Bill Ziemba) are represented... even the original paper by Bernouilli.
Buy 2 copies, just in case you lose one. This book has more meat than any other book in decision theory, economics, finance, etc...
32 of 42 people found the following review helpful.
Another Book Review from the Aleph Blog
By David Merkel
I have not read this book. I read almost all books that I review, so I disclose when I have merely scanned a book such as this.
Why scan? First, I didn't ask for the book. Second, it is 800+ pages long. Third, it is a series of academic articles defending and attacking the Kelly Criterion -- it will have a very specific audience that cares about the academic side of the debate. The popular side is covered by the book, "Fortune's Formula," which I have favorably reviewed here.
The simple way to phrase the argument for the Kelly Criterion is this: you have an advantage versus the markets for whatever reason. You have an edge on average, and the odds are tilted in your favor. You size your bets as a ratio of edge over odds. If your edge is durable, and the odds are calculated right, the optimal decision leads to the best compound growth of capital on average.
Samuelson sits in his ivory tower, where only efficient markets exist. Those of us that are practitioners know that the markets are hard, but not efficient.
To me, the Kelly Criterion is intuitive, whereas the ideas of Modern Portfolio Theory are a stretch. They don't fit the way the market operates.
Who would benefit from this book: If you are really interested in the Kelly Criterion debate , and are willing to pay up to get a good summary of the debate, it is available here. Note: you have to like math.
3 of 4 people found the following review helpful.
Five Stars
By john hopkins
Complex but complete, covers fortunes formula from every angle
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