KELLY CAPITAL GROWTH INVESTMENT CRITERION, THE: THEORY AND PRACTICE (World Scientific Handbook in Financial Economics)

by Leonard C. MacLean (Editor), Edward O. Thorp (Editor), William T. Ziemba (Editor)

7 customer reviews

ISBN-13: 978-9814383134

ISBN-10: 9814383139

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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.

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Editorial Reviews

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The present handbook assembles in an impressive way the classical papers and also provides the link to modern research. It also presents important papers with a critical view towards the Kelly criterion. Among them figures the famous three-page paper of P. Samuelson from 1979 which is written by using exclusively one-syllable words. -- Professor Walter Schachermayer "Faculty of Mathematics, University of Vienna"

For those who have heard of the Kelly mythos and want to explore the science behind it, this book will be an instant classic. The editors have collected all the pivotal original papers, spanning centuries and the rarely bridged gulf between theory and practice. This book is indispensable for anyone interested in Kelly's legacy. -- William Poundstone "Author of "Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street""

From the Inside Flap

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.

Product details

Series: World Scientific Handbook in Financial Economics (Book 3)
Paperback: 882 pages
Publisher: World Scientific Publishing Company (February 11, 2011)
Language: English
ISBN-10: 9814383139
ISBN-13: 978-9814383134
Product Dimensions: 6.7 x 1.7 x 9.6 inches
Shipping Weight: 3.3 pounds (View shipping rates and policies)
Average Customer Review: 7 customer reviews
Amazon Best Sellers Rank: #107,941 in Books (See Top 100 in Books)
- #29 in Books > Science & Math > Evolution > Game Theory
- #85 in Books > Textbooks > Business & Finance > Investments & Securities
- #209 in Books > Textbooks > Business & Finance > Finance

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Finally, a compendium of the most rigorous research (gamblers ruin based) on risky decisions

November 29, 2013

Format: PaperbackVerified Purchase

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...

139 people found this helpful

Comment

September 7, 2015

Format: PaperbackVerified Purchase

Excellent, bought it on Nassim's recommendation, quite tough for me though. Requires mathematical maturity.

5 people found this helpful

Comment

May 10, 2018

Format: Kindle EditionVerified Purchase

Needlessly detailed and does not give the investor a sound opinion or point of view on advantages versus the disadvantages of using and calculating trading capital with the Kelly criterion.

One person found this helpful

Comment

The Holy Grail of Mathamatics for Investing

February 10, 2017

Format: Paperback

Ed Thorp, Leonard Maclean, and William Ziemba wrote a masterpiece here. For me, this is a very important textbook because it captures the importance of position size. What many people in the financial world fail to recognize is the tethered relationship that exists between probability expectations and position size. This book doesn't just show the calculations for the Kelly criterion, but it also provides methods for trying to develop a good expected value for certain types of events and outcomes. If you're a serious investor, you would be crazy to pass on this book. For one reason, Ed Thorp is the living example of why the Efficient Market Hypothesis is false - simply look at his 227 months out of 230 for beating the market and you'll see what I'm talking about... Thank you for sharing this information gentleman!

8 people found this helpful

Comment

Kindle version -- bad OCR

October 21, 2017

Format: Kindle EditionVerified Purchase

Kindle version appears to be a bad OCR. The mathematical notation makes this problem glaring.

6 people found this helpful

Comment

October 19, 2014

Format: Kindle EditionVerified Purchase

Complex but complete, covers fortunes formula from every angle

6 people found this helpful

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Another Book Review from the Aleph Blog

June 4, 2012

Format: Hardcover

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.

47 people found this helpful

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