World Scientific Handbook in Financial Economic Series Vol.

3
THEORY and PRACTICE
THE
KELLY CAPITAL GROWTH
INVESTMENT CRITERION
E d i t o r s ' jj
Leonard C MacLean
Dalho us i e Uni ver s i t y, USA
Edward 0 Thorp
Uni ver s i t y o f Cali fo r ni a, Ir vi ne, USA
William T Ziemba
Mat hemat i cal Ins t i t ut e, Oxfo r d Uni ver s i t y, UK and Uni ver s i t y o f Br i t i s h Co lumbi a, Canad a
i World Scien tific
NEW JERSEY L O N D O N SI N G A P O R E B EI J I N G SHA N G HA I HO N G K O N G T A I P EI C HEN N A I
Contents
Preface xv
List of Contributors xvii
Acknowledgments xxi
Pictures xxv
Part I: The Early Ideas and Contributions
1. Introduction to the Early Ideas and Contributions 3
2. Exposition of a New Theory on the Measurement of Risk 11
(translated by Louise Sommer)
D. Bernoulli
Econometrica, 22, 23-36 (1954)
3. A New Interpretation of Information Rate 25
J. R. Kelly, Jr.
Bell System Technical Journal, 35, 917-926 (1956)
4. Criteria for Choice among Risky Ventures 35
H. A. Latane
Journal of Political Economy, 67, 144-155 (1959)
5. Optimal Gambling Systems for Favorable Games 47
L. Breiman
Proceedings of the 4th Berkeley Symposium on
Mathematical Statistics and Probability, 1, 63-68 (1961)
viii Contents
6. Optimal Gambling Systems for Favorable Games 61
E. O. Thorp
Review of the International Statistical Institute, 37(3),
273-293 (1969)
7. Portfolio Choice and the Kelly Criterion 81
E. O. Thorp
Proceedings of the Business and Economics Section of
the American Statistical Association, 215-224 (1971)
8. Optimal Investment and Consumption Strategies under Risk 91
for a Class of Utility Functions
N. H. Hakansson
Econometrica, 38, 587-607 (1970)
9. On Optimal Myopic Portfolio Policies, with and without 113
Serial Correlation of Yields
N. H. Hakansson
Journal of Business, 44, 324-334 (1971)
10. Evidence on the "Growth-Optimum-Model" 125
R. Roll
The Journal of Finance, 28(3), 551-566 (1973)
Part II: Classic Papers and Theories
11. Introduction to the Classic Papers and Theories 143
12. Competitive Optimality of Logarithmic Investment 147
R. M. Bell and T. M. Cover
Mathematics of Operations Research, 5(2),
161-166 (1980)
13. A Bound on the Financial Value of Information 153
A. R. Barron and T. M. Cover
IEEE Transactions of Information Theory, 34(5),
1097-1100 (1988)
Contents ix
14. Asymptotic Optimality and Asymptotic Equipartition 157
Properties of Log-Optimum Investment
P. H. Algoet and T. M. Cover
Annals of Probability, 16(2), 876-898 (1988)
15. Universal Portfolios 181
T. M. Cover
Mathematical Finance, 1(1), 1-29(1991)
16. The Cost of Achieving the Best Portfolio in Hindsight 211
E. Ordentlich and T. M. Cover
Mathematics of Operations Research, 23(4),
960-982 (1998)
17. Optimal Strategies for Repeated Games 235
M. Finkelstein and R. Whitley
Advanced Applied Probability, 13, 415-428 (1981)
18. The Effect of Errors in Means, Variances and Co-Variances 249
on Optimal Portfolio Choice
V. K. Chopra and W. T. Ziemba
Journal of Portfolio Management, 19, 6-11 (1993)
19. Time to Wealth Goals' in Capital Accumulation 259
L. C. MacLean, W. T. Ziemba, and Y. Li
Quantitative Finance, 5(4), 343-355 (2005)
20. Survival and evolutionary Stability of Rule the Kelly 273
I. V. Evstigneev, T. Hens, and K. R. Schenk-Hoppe
(2010)
x Contents
21. Application of the Kelly Criterion to Ornstein-Uhlenbeck 285
Processes
Y. Lv and B. K. Meister
Lecture Notes of the Institute for Computer Sciences, 4,
1051-1062 (2009)
Part III: The Relationship of Kelly Optimization to
Asset Allocation
22. Introduction to the Relationship of Kelly Optimization to 301
Asset Allocation
23. Survival and Growth with a Liability: Optimal Portfolio 307
Strategies in Continuous Time
S. Browne
Mathematics of Operations Research, 22(2), 468-493
(1997)
24. Growth versus Security in Dynamic Investment Analysis 331
L. C. MacLean, W. T. Ziemba, and G. Blazenko
Management Science, 38(11), 1562-1585 (1992)
25. Capital Growth with Security 355
L. C. MacLean, R. Sanegre, Y. Zhao, and W. T. Ziemba
Journal of Economic Dynamics and Control, 28(4),
937-954 (2004)
26. Risk-Constrained Dynamic Active Portfolio Management 373
S. Browne
Management Science, 46(9), 1188-1199 (2000)
27. Fractional Kelly Strategies for Benchmark Asset Management 385
M. Davis and S. Lleo (2010)
28. A Benchmark Approach to Investing and Pricing 409
E. Platen (2010)
Contents xi
29. Growing Wealth with Fixed-Mix Strategies 427
" M. A. H. Dempster, I. V. Evstigneev, and
K. R. Schenk-Hoppe (2010)
Part IV: Critics and Assessing the Good and Bad
Properties of Kelly
30. Introduction to the Good and Bad Properties of Kelly 459
31. Lifetime Portfolio Selection by Dynamic Stochastic 465
Programming
P. A. Samuelson
Review of Economics and Statistics, 51, 239-246 (1969)
32. Models of Optimal Capital Accumulation and Portfolio 473
Selection and the Captial Growth Criterion
W. T. Ziemba and R. G. Vickson (2010)
33. The "Fallacy" of Maximizing the Geometric Mean in Long 487
Sequences of Investing or Gambling
P. A. Samuelson
Proceedings National Academy of Science, 68(10),
2493-2496 (1971)
34. Why We Should Not Make Mean Log of Wealth Big Though 491
Years to Act Are Long
P. A. Samuelson
Journal of Banking and Finance, 3, 305-307 (1979)
35. Investment for the Long Run: New Evidence for an Old Rule 495
H. M. Markowitz
Journal of Finance, 31(5), 1273-1286 (1976)
36. Understanding the Kelly Criterion 509
E. O. Thorp
Wilmott, May and September (2008)
xii Contents
37. Concave Utilities Are Distinguished by Their 525
Optimal Strategies
E. O. Thorp and R. Whitley
Colloquia Mathematica Societatis Janos Bolyai,
813-830 (1972)
38. Medium Term Simulations of the Full Kelly and 543
Fractional Kelly Strategies Investment
L. C. MacLean, E. O. Thorp, Y. Zhao, and
W. T. Ziemba (2010)
39. Good and Bad Kelly Properties of the Kelly Criterion 563
L. C. MacLean, E. O. Thorp, and W. T. Ziemba (2010)
Part V: Utility Foundations
40. Introduction to the Utility Foundations of Kelly 575
41. Capital Growth Theory 577
N. H. Hakansson and W. T. Ziemba
In R. A. Jarrow, V. Maksimovic, and W. T. Ziemba
(Eds.), Finance, Handbooks in OR & MS, Volume 9,
65-86. North Holland (1995)
42. A Preference Foundation for Log Mean-Variance Criteria in 599
Portfolio Choice Problems
D. G. Luenberger
Journal of Economic Dynamics and Control, 17,
88-906 (1993)
43. Portfolio Choice with Endogenous Utility: A Large 619
Deviations Approach
M. Stutzer
Journal of Econometrics, 116, 365-386 (2003)
Contents xiii
44. On Growth-Optimality vs. Security against Underperformance 641
M. Stutzer (2010)
Part VI: Evidence of the Use of Kelly Type Strategies by the
Great Investors and Others
45. Introduction to the Evidence of the Use of Kelly Type 657
Strategies by the Great Investors and Others
46. Efficiency of the Market for Racetrack Betting 663
D. B. Hausch, W. T. Ziemba, and M. E. Rubinstein
Management Science, 27, 1435-1452 (1981)
47. Transactions Costs, Extent of Inefficiencies, Entries and 681
Multiple Wagers in a Racetrack Betting Model
D. B. Hausch and W. T. Ziemba
Management Science, 31, 381-394 (1985)
48. The Dr. Z Betting System in England 695
W. T. Ziemba and D. B. Hausch
In D. B. Hausch, V. Lo, and W. T. Ziemba (Eds.),
Efficiency of Racetrack Betting Markets, 567-574.
World Scientific (2008)
49. A Half Century of Returns on Levered and Unlevered Portfolios 703
of Stocks, Bonds and Bills, with and without Small Stocks
R. R. Grauer and N. H. Hakansson
Journal of Business, 592, 287-318 (1986)
50. A Dynamic Portfolio of Investment Strategies: Applying 735
Capital Growth with Drawdown Penalties
J. M. Mulvey, M. Bilgili, and T. M. Vural (2010)
xiv Contents
51. Intertemporal Surplus Management 753
M. Rudolf and W. T. Ziemba
Journal of Economic Dynamics and Control, 28,
975-990 (2004)
52. The Symmetric Downside-Risk Sharpe Ratio and the 769
Evaluation of Great Investors and Speculators
W. T. Ziemba
Journal of Portfolio Management, 32(1), 108-122
(2005)
53. Postscript: The Renaissance Medallion Fund 785
R. E. S. Ziemba and W. T. Ziemba
In Scenarios for Risk Management and Global
Investment Strategies, 295-298. Wiley (2007)
54. The Kelly Criterion in Blackjack Sports Betting and the 789
Stock Market
E. O. Thorp
In S. A. Zenios and W. T. Ziemba (Eds.),
Handbook of Asset and Liability Management,
Volume 1, 387-428. Elsevier (2006)
Bibliography 833
Author Index 839
Subject Index 843