Kelly’s formula is a theoretical benchmark for deciding the appropriate position size when gambling. A divergence in attitude towards this theory illustrates the disconnect between academicians and practitioners, and the necessity of closer collaboration between the two circles, a point we argued in The Two Towers of Finance.
To understand the essence of Kelly’s formula, let us consider the question: Can one lose money in a game in which one has a favorable probability of winning? The answer is, absolutely yes. To see why, think of the simple game of tossing a biased coin: heads means that the player wins
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