Monday, December 31, 2012

The Kelly Optimization Model (from Robert Hagstrom, The Essential Buffett, p. 143)


The Kelly Optimization Model, often called the optimal growth strategy, is based on the concept that if you know the probability of success, you bet the fraction of your bankroll that maximizes the growth rate.  It is expressed as a formula:


                        2p – 1 = x


where 2 times the probability of winning (p) minus 1 equals the percentage of the total that should be bet (x).  For example, if the probability of beating the house is 55 percent, you should bet 10 percent of your bankroll to achieve the maximum growth of your winnings.


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