My Authors
Read all threads
There are two side to the Kelly Criterion which I think often get equated as the same when they really are not.

Traditional Kelly betting is about limiting your exposure to a risky bet. The bet in question is usually a "bet" in that when you lose, you lose everything you expose.
So you scale back and don't risk everything. Most casino games fit this description as do some financial instruments like options.

The optimal leverage here is less than 1. You want to hold cash on the side to buffer the future losses.
But standard investment assets, don't work this way.

I showed here, that individual stocks are effectively full Kelly bets.

Just buying one stock is the appropriate "size", as they have an optimal leverage of 1.…
You can go from there and see that the S&P500 has an optimal leverage of around 2. A 60/40 portfolio is closer to 4, and a risk parity portfolio is closer to 8.

In these cases the Kelly criterion says to increase exposure, not limit it.
Directionally, this is a pretty big difference. For one, the first example shrinks errors, and the second example expands them. This is not trivial, as an error with leverage can potentially cause you to owe money.…
Secondly, limiting exposure is a single player decision. Its easy to do by just investing less.

Increasing exposure beyond what you own requires some else to lend you something. It requires other to be involved and other promises to be made.
Leading to the realization there is a bit of convexity built into the direction of the scaling factor.

Because of this, I feel that Kelly betting strategies that increase exposure are a slightly different animal than ones that limit exposure and need to be handled differently.
Missing some Tweet in this thread? You can try to force a refresh.

Keep Current with breakingthemarket

Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!

Twitter may remove this content at anytime, convert it as a PDF, save and print for later use!

Try unrolling a thread yourself!

how to unroll video

1) Follow Thread Reader App on Twitter so you can easily mention us!

2) Go to a Twitter thread (series of Tweets by the same owner) and mention us with a keyword "unroll" @threadreaderapp unroll

You can practice here first or read more on our help page!

Follow Us on Twitter!

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3.00/month or $30.00/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!