The Kelly Capital Growth Investment Criterion: Theory and Practice (World Scientific Handbook in Financial Economics)

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9789814383134: The Kelly Capital Growth Investment Criterion: Theory and Practice (World Scientific Handbook in Financial Economics)
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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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About the Author:

Leonard C MacLean is the Herbert S Lamb Chair in Business at the School of Business Administration, Dalhousie University, Halifax, Nova Scotia, Canada. His research interests include stochastic optimization models in finance, and models for repairable systems in aviation, funded by grants from the Natural Sciences and Engineering Research Council of Canada.

Edward O Thorp is widely known as the author of the 1962 Beat the Dealer, which was the first book to prove mathematically that blackjack could be beaten by card counting, and the 1967 Beat the Market, which showed how warrant option markets could be priced and beaten. He is regarded as one of the best hedge fund managers in the world. He is also regarded as the co-inventor of the first wearable computer along with Claude Shannon. Thorp received his PhD from the University of California, Los Angeles in 1958 and worked at MIT from 1959 to 1961. He was a professor of mathematics from 1965 to 1977 and a professor of mathematics and finance from 1977 to 1982 at the University of California, Irvine.

William T Ziemba is the Alumni Professor (Emeritus) of Financial Modeling and Stochastic Optimization in the Sauder School of Business, University of British Columbia, Canada where he taught from 1968 to 2004. He obtained his PhD from the University of California, Berkeley in 1969. He now teaches as a Visiting Professor at world-reknowned institutions including Cambridge, Oxford, London School of Economics, Reading ICMA Centre, and Warwick in the UK; Stanford, UCLA, Berkeley, Chicago and MIT in the US; Bergamo and Venice in Italy; Toulouse and EDHEC in France; Tsukuba in Japan; the National University of Singapore and the National Technological University in Singapore. Leading financial institutions, which he has been consultant to, include the Frank Russell Company, Morgan Stanley, Buchanan Partners, Gordon Capital, Matcap Capital, and Private International Wealth Management. His research is in asset-liability management, portfolio theory and practice, security market imperfections, Japanese and Asian financial markets, sports and lottery investments, and applied stochastic programming.

Review:

"This is a fantastic reference covering the theory and practice of the field beautifully organized and produced. I have already used it and I will refer it to my students and colleagues." -- Professor David G Luenberger, Stanford University

"This volume provides a fascinating historical account and critical assessment of the Kelly criterion (expected logarithmic utility maximization) as a universal criterion for the tradeoff between risk and return in portfolio management and gambling. Whereas economists have, by now, lost their innocence, recognizing that investors may have heterogeneous risk-return tradeoffs which may or may not be codifiable with von Neumann-Morgenstern preferences and even with rational decision-making, the quest for the Holy Grail of a universal criterion vividly documents early attempts to lay the scientific micro-foundations of economics." -- George M Constantinides, Leo Melamed Professor of Finance, The University of Chicago, USA

"This book provides a comprehensive survey of research and applications on the Kelly growth optimal strategy that maximizes the expected utility of the log of final wealth ... There are numerous advantages to the Kelly strategy, especially for long-term investors who face a long sequence of similar decisions ... But a disadvantage is the possibility of severe downside consequences over a small or even moderate or large number of decisions ... Any investor with an eye to improving their long-term performance should be aware of the Kelly strategy and its cousins ... This book provides a fine coverage of these topics from original sources and recent research publications." --Quantitative Finance

"The tragically short-lived genius John Kelly Jr. is best remembered for one of the most original and far-reaching ideas in modern finance. The Kelly criterion can be described as a gambling system that really works, in that it achieves the maximum long-term return from a favorable speculation. Kelly's idea has long had a cult following among people ranging from hedge fund managers to blackjack players.

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

"In 1738 Daniel Bernoulli wrote a path-breaking paper. He gave a solution to the St. Petersburg Paradox by suggesting the use of a utility function. Arguing that marginal utility should be indirectly proportional to a person's wealth, he arrives at the logarithm. It can safely be stated that the idea of utility functions and marginal utility is the most precious gift which mathematics ever made to economics. This idea shaped the form of economic thinking in a decisive way over the past centuries. A central role is played, from the very early days on, by the logrithmic utility. In a dynamic setting this criterion, now named after the seminal work of J Kelly in 1956, leads in average to the optimal growth rate of a portfolio.

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

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