Investing: The Last Liberal Art (Columbia Business School Publishing)

by Robert G. Hagstrom

The Kelly criterion, as applied to investing, is also known as the Kelly Optimization Model, which in turn is called the optimal growth strategy. It provides a way to determine, mathematically, the optimal size of a series of bets that would maximize the growth rate of a portfolio over time, and it’s based on the simple idea 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 minus 1 equals the percentage of one’s bankroll that should be bet. For example, if the probability of beating the house is 55 percent, you should bet 10 percent of your bankroll to achieve maximum growth of your winnings. If the probability is 70 percent, bet 40 percent. And if you know the odds of winning are 100 percent, the model would say, bet your entire bankroll.