Another common error in the psychology literature concerns what is called “mental accounting.” The Thorp, Kelly, and Shannon school of information theory requires that, for an investment strategy to be ergodic and eventually capture the return of the market, agents increase their risks as they are winning, but contract after losses, a technique called “playing with the house money.” In practice, it is done by threshold, for ease of execution, not complicated rules: you start betting aggressively whenever you have a profit, never when you have a deficit, as if a switch was turned on or off.
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