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Kelly criterion

Formula for bet sizing that maximizes the expected logarithmic value / From Wikipedia, the free encyclopedia

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In probability theory, the Kelly criterion (or Kelly strategy or Kelly bet) is a formula for sizing a bet. The Kelly bet size is found by maximizing the expected value of the logarithm of wealth, which is equivalent to maximizing the expected geometric growth rate. It assumes that the expected returns are known and is optimal for a bettor who values their wealth logarithmically. J. L. Kelly Jr, a researcher at Bell Labs, described the criterion in 1956.[1] Under the stated assumptions, the Kelly criterion leads to higher wealth than any other strategy in the long run (i.e., the theoretical maximum return as the number of bets goes to infinity).

Example of the optimal Kelly betting fraction, versus expected return of other fractional bets.

The practical use of the formula has been demonstrated for gambling,[2][3] and the same idea was used to explain diversification in investment management.[4] In the 2000s, Kelly-style analysis became a part of mainstream investment theory[5] and the claim has been made that well-known successful investors including Warren Buffett[6] and Bill Gross[7] use Kelly methods.[8] Also see Intertemporal portfolio choice.

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