10 ms·

Nassim Taleb, Absorbent Barriers and House Money

149 points by bko 9y ago

chollida1 9y ago
Wow, the work he did on simulating his payout is almost exactly what I used to have people do as part of our interviewing. IMHO It was one of the most telling tests I could give a potential trader, not necessarily for quants as this should be considered the quant equivalent of fizzbuzz. Victor Haghani of Long Term Capital Mangement fame, yep those guys, did a similar experiment with bet sizing and betting on a loaded coin and sadly even people who should have known better, math majors, didn't fare very well in his experiment. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963
- typon 9y ago
  I looked up the first author on Wikipedia: > Victor Haghani (born c. 1962[1]) is an Iranian-American financier,[2] one of the founding partners of Long Term Capital Management (LTCM), a hedge fund which collapsed in 1998 and was eventually bailed out by a consortium of leading banks.
- 21 9y ago
  Taleb has a lot of disdain for the LTCM guys: "Mr Taleb argues convincingly that the spectacular collapse in 1998 of Long-Term Capital Management was caused by the inability of the hedge fund's managers to see a world that lay outside their flawed models. And yet those models are still widely used today." "By many’s reckoning, LTCM both defined and emboldened Nassim Taleb. The episode was a microcosm of everything he eventually stood for and against. His resentment against economists grew. He became convinced that they totally do not understand risk. He saw the fragility of the financial system and how dependent the entire ecosystem is on one another. He became disgusted when LTCM fund managers, despite the damage they have done, walked away from the fiasco relatively unscathed and went on to start more funds. He became the biggest advocate of having Skin in the Game."
  - tptacek 9y ago
    Disdain for LTCM isn't exactly an iconoclastic, or even interesting, position to take. They're among the worst trading catastrophes in history. A good book has been written about LTCM, but it's not Taleb's; it's Lowenstein's _When Genius Failed_.
    - pdog 9y ago
      > Disdain for LTCM isn't exactly an iconoclastic, or even interesting, position to take. How many people took that position before it blew up?
      - tptacek 9y ago
        Famously, Taleb is supposed to have predicted LTCM. I've read FBR and Swan, but not recently, and took a couple minutes to try to track down the details of this prediction, with little luck. I found numerous references to his having predicted the demise of hedge funds "like" LTCM (my clock will also strike 4:23 at least twice in the next 24 hours). Does anyone have a good cite for this?
        defen 9y ago
        I'm not sure he called them out by name. If you read `Against VAR` [1] from 1997 (LTCM blew up in 1998) you see basically all the ideas of The Black Swan / Fooled By Randomness. LTCM was doing all the things that he says are risky. The guy who wrote "In Defense of VAR" on that same page subsequently wrote "Risk Management Lessons from Long-Term Capital Management"[2]. Also in Taleb's 1997 book "Dynamic Hedging", chapter 9 "Vega and the Volatility Surface" talks about liquidity as one of the pre-eminent risks of an option book (as opposed to individual option positions). [1] http://www.derivativesstrategy.com/magazine/archive/1997/0497fea2.asp http://www.derivativesstrategy.com/magazine/archive/1997/049... [2] https://merage.uci.edu/~jorion/papers/ltcm.pdf https://merage.uci.edu/~jorion/papers/ltcm.pdf
OscarCunningham 9y ago
What Taleb shows is that people should become more willing to bet as they move away from the "absorbing barrier" of having so little money that they have to quit the game. But he phrases this in terms of justifying the fact that people are more willing to bet with "house money" (money that they have already won) than their own. This is clearly wrong because the starting point is always higher than the absorbing barrier. I think Taleb is a bit too eager to criticise others, even when his mathematics isn't actually applicable to the situation.
- mjb 9y ago
  "A bit too eager to criticize others" is a understatement. Taleb has a lot of interesting things to say, and some of them are even reasonably novel. Unfortunately his general "everybody but me is stupid" approach makes his message much less useful and accessible than it otherwise would be. This is a good example of that problem. I find this really unfortunate, because Taleb's message about systems behavior being dominated by tail behavior, and about the risks systems not being designed to tolerate that behavior, are very interesting and broadly applicable. Unfortunately, the medium makes the message less effective. I often think of Taleb as a sort of counter-example when thinking about how to teach and communicate difficult concepts.
  - te_chris 9y ago
    He's such a thin-skinned snowflake. I enjoyed The Black Swan but didn't know much about him as a person. He should give up twitter, or stop reading reviews. His fans are hilarious too: he's created a whole cult of redundant pedants.
    - vvdcect 9y ago
      >whole cult of redundant pedants. aspiring despots
  - pfortuny 9y ago
    The long tails and the lack of mean of important distributions is essential. However, we are losing those concepts because of his belligerance. A pity.
root_crontab 9y ago
I see too many of these. Write code to simulate something and obtain an inconclusive version of a result you can simply derive and prove definitively using statistics.
jerf 9y ago
This idea has a lot of legs if you examine it. One of the more interesting points I've heard from Jordan Peterson in one of his criticisms of postmodernism is this: Postmodernism observes that after centuries of trying, we don't seem to have an objective standard for ethics or philosophy (or at least one that we can all agree on). Postmodernism, to the extent that one can refer to the whole movement in a short sentence, then tends to assume that therefore there are no distinctions between moral frames or perspectives, and from there proceeds to go in a different direction and analyzes everything simply in terms of power, because they decided that's the only thing that matters since moralities and philosophies otherwise have no meaning. Don't get too tied up in the details of that summary; I'm well aware of just how brutal that summary is. But the details of the summary aren't what's important; what's important is the observation that there are absorbent barriers in philosophy and especially morality. You can't pursue a morality that results in your death, especially if it results in a quick death. There's some others too, but that's biggest and the most obvious. Civilizational death is another one; more abstract, but also a rich vein of observations. For example, there's a lot more people living people advocating for humanity to be killed off for the planet than dead people advocating for humanity to be killed off for the planet's sake. It is impossible for the living to observe any other outcome. This does not lead us via simple, universally-agreeable philosophical steps to a universally-agreed upon morality. But it does create distinctions between different moralities and philosophies, and once you admit that into the world, it once again becomes valid to study different philosophies and moralities again without having to accept the postmodernistic "throw your hands in the air and give up ever being able to determine anything, and then go study something else instead". It's still nowhere near a mathematically rigorous world by any means, but it's no longer hopeless. (Bonus observation 1: No, this is not simply utilitarianism. Consider utilitarianism as a spectrum of "how concerned am I about 'utility'". Utilitarianism is the idea that we should be very far to the side of considering that, if not considering it solely; on a spectrum from 0 to 1, utilitarianism is that we should be close to or on 1. This observation is the complementary observation that we can not be close to or on 0. But we might still be on, say, 0.5, which is not "utilitarianism" but may be enough to create philosophies that still keep us alive. This observation also does not depend on "valuing" life over death, because it is on a far more primal and brutal level than that. It is the factual observation that if you hit one of these absorbing barriers you are no longer a participant in philosophy, not a normative statement about whether that is or is not a good thing.) (Bonus observation 2: This is the beginning of the path, not the end.)
bluecalm 9y ago
>>So, if you look at the world as repetition of bets, under condition of survival, then mental accounting is not only not irrational but is necessary. Any other strategy would be effectively irrational. No, it's still irrational and it doesn't matter if there is repetition of bets or just one available. Depending on your total net worth, living conditions and values you have there are good bets and bad bets. A good bet is a bet which maximizes expected utility of your money. It changes depending on your net worth of course. It doesn't matter if you have just won or lost (this is mental accounting) it matters what's your total net worth is at given time. >>Actually, what I’m saying is even stronger. I am saying that even if you have the edge, in the presence of the probability of ruin, you will be ruined. Even if you had the edge … If you play long enough. He wouldn't pass 1st year college math course with that one. >>Unless you engage in strategies designed by traders and rediscovered by every single surviving trader, very similar to what we call, something called the Kelly Criterion, which is to play with the house money He doesn't grok what Kelly Criterion is either. Kelly Criterion determines a size of the bet which maximizes utility of money modeled as a logarithmic funciton. That's it. It doesn't matter if there is string of bets available or just one bet. If you have just won or lost doesn't matter either (only your total net worth at given point). >>And this is called, playing with the market money or playing with the house money. It's called being confused about basic math and economic concepts and then criticizing people who worked on those. Typical Taleb: confused, wrong, having no new insights to offer but making up for those with new terms (absorbent barriers, really?) and a lot of words.
- cardmagic 9y ago
  >> Actually, what I’m saying is even stronger. I am saying that even if you have the edge, in the presence of the probability of ruin, you will be ruined. Even if you had the edge … If you play long enough. > He wouldn't pass 1st year college math course with that one. Seems pretty straightforward to me. Let's say you play a game with an edge where you win 2x your money 99% of the time. But if you lose once, you lose all your money (1% risk of ruin). If you play this game 70 times, you are very likely to end up ruined. It’s a lot like smoking. One cigarette won’t kill you, but add up the probability cigarette after cigarette, pack after pack, year after year and the probability starts to skyrocket.
deleted 9y ago
[deleted]
apo 9y ago
The author quotes Taleb: ...Unless you engage in strategies designed by traders and rediscovered by every single surviving trader, very similar to what we call, something called the Kelly Criterion, which is to play with the house money. ... And later restates: What Taleb said is we should be more aggressive with the house money. AFAICT, the Kelly Criterion has nothing to do with playing with house money. Instead, Kelly tells you how much of your wallet to wager given the payout and probability of winning. The source of the money you stake is irrelevant. Dice don't care whether your wager came from the house or your 401k. For example, in a coin toss biased 60% to heads with a 2x payout for win, you should bet 20% of your wallet on heads and keep doing that no matter which way the flips go (2p - 1 = 2*0.6 - 1 = 0.2). If p ≤ 0.5, don't bet. https://en.wikipedia.org/wiki/Kelly_criterion https://en.wikipedia.org/wiki/Kelly_criterion https://www.youtube.com/watch?v=d4yzXbdq2DA https://www.youtube.com/watch?v=d4yzXbdq2DA Playing this strategy optimizes your return and ensures you can never go bust, thereby missing out on the guaranteed payout over enough bets.
- andrewla 9y ago
  I believe the point he is making about "house money" and the Kelly Criterion is the size of the bet corresponds to how far ahead you are -- as you get farther ahead, your bets will get larger. The problem with the comparison is that if you have one trader who started with $20, and another with $100, but they both currently have $50, they will both, by the Kelly criterion, be betting the same amount of money, even though once trader is trading with "house money" and the other is not. They're still trading without memory, which is the point that he was trying to refute, as I understand it.
- tomp 9y ago
  Is he actually arguing that "house money" is different from "your money" or is he just reusing existing terminology? IIRC, the idea of "house money" was invented by earlier researchers who tried to explain why people would bet more after winning. Obviously "keeping score of your wealth" explains the effect just as well as "playing with house money".
  - apo 9y ago
njarboe 9y ago
The interesting thing I got out of this analysis is that, if you have a slight edge of 1%, having the constant percentage betting strategy is much better, if you have a large (100,000) number of bets. Having a log scale would be nice to see approximately where the two strategies returns diverge. This got me thinking. One thing that is not discussed is that in real life trading one does not know what percentage advantage one has. Many successful traders rely on subconscious processes for part of their trading strategy that they have no way of examining, but seems to work(sometimes). If the only way to find out what your expected return is(your edge), is to bet and see what happens (maybe this is really the reason one needs "skin in the game") then ramping up your betting when you are winning is a really good idea. When you are losing money it is likely your expected return is negative and you should start scaling back your bets until you find an edge again. It would be interesting to run this code with variable rates of return over time, including negative ones, where one scales the bet size not on your net capital but on (the percentage win on the last n bets)*(capital). I'm sure this is all in some book written in the 18th century as people have been trading in markets for a long time.
- danieltillett 9y ago
  What a lot of traders do is use 50% of the Kelly limit to cover this risk. At worst by staying under the Kelly limit you reduce your return, while if you exceed it you will blow up at some point.
- jbp 9y ago
  Don't know about 18th century, but some what similar strategy is already mentioned by Taleb in the interview: Kelly Criterion.
  - njarboe 9y ago
    I thought what I was saying was quite a bit different. If one is using the Kelly Criterion, one needs to know what the probability of winning and odds paid for a win. Traders generally don't know these at all and only can find them out by making the trade and seeing what happens. Of course when the Kelly Criterion is known and constant, one can make the optimal bets and get rich, but those situations don't exist in real life (unless there is some kind of monopoly or external force being used to make people take the other (loosing side) of the bet). The iterative thinking of the the Kelly Criterion must be part of a traders mindset, but markets never understood well enough to where this formula can be strictly applied. A bit strange to see Taleb talk about a casino situation to explain his thinking. Elsewhere he mocks such "casino odds" view of the world as very unrealistic an bemoans that such a view will cause one grief if you use those ideas with "skin in the game". ps. I've only read "Anti-Fragile" and some of his blog essays.
ikeboy 9y ago
I believe the response to this is that the actual increased willingness to bet is way higher than could possibly be justified by the paltry amounts won. If e.g. your net worth is 10k, you win 500, and suddenly you're twice as willing to bet 500, something is off.

149 points by bko 9y ago

Wow, the work he did on simulating his payout is almost exactly what I used to have people do as part of our interviewing. IMHO It was one of the most telling tests I could give a potential trader, not necessarily for quants as this should be considered the quant equivalent of fizzbuzz. Victor Haghani of Long Term Capital Mangement fame, yep those guys, did a similar experiment with bet sizing and betting on a loaded coin and sadly even people who should have known better, math majors, didn't fare very well in his experiment. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963

typon 9y ago
I looked up the first author on Wikipedia: > Victor Haghani (born c. 1962[1]) is an Iranian-American financier,[2] one of the founding partners of Long Term Capital Management (LTCM), a hedge fund which collapsed in 1998 and was eventually bailed out by a consortium of leading banks.
21 9y ago
Taleb has a lot of disdain for the LTCM guys: "Mr Taleb argues convincingly that the spectacular collapse in 1998 of Long-Term Capital Management was caused by the inability of the hedge fund's managers to see a world that lay outside their flawed models. And yet those models are still widely used today." "By many’s reckoning, LTCM both defined and emboldened Nassim Taleb. The episode was a microcosm of everything he eventually stood for and against. His resentment against economists grew. He became convinced that they totally do not understand risk. He saw the fragility of the financial system and how dependent the entire ecosystem is on one another. He became disgusted when LTCM fund managers, despite the damage they have done, walked away from the fiasco relatively unscathed and went on to start more funds. He became the biggest advocate of having Skin in the Game."
- tptacek 9y ago
  Disdain for LTCM isn't exactly an iconoclastic, or even interesting, position to take. They're among the worst trading catastrophes in history. A good book has been written about LTCM, but it's not Taleb's; it's Lowenstein's _When Genius Failed_.
  - pdog 9y ago
    > Disdain for LTCM isn't exactly an iconoclastic, or even interesting, position to take. How many people took that position before it blew up?
    - tptacek 9y ago
      Famously, Taleb is supposed to have predicted LTCM. I've read FBR and Swan, but not recently, and took a couple minutes to try to track down the details of this prediction, with little luck. I found numerous references to his having predicted the demise of hedge funds "like" LTCM (my clock will also strike 4:23 at least twice in the next 24 hours). Does anyone have a good cite for this?
      - defen 9y ago
        I'm not sure he called them out by name. If you read `Against VAR` [1] from 1997 (LTCM blew up in 1998) you see basically all the ideas of The Black Swan / Fooled By Randomness. LTCM was doing all the things that he says are risky. The guy who wrote "In Defense of VAR" on that same page subsequently wrote "Risk Management Lessons from Long-Term Capital Management"[2]. Also in Taleb's 1997 book "Dynamic Hedging", chapter 9 "Vega and the Volatility Surface" talks about liquidity as one of the pre-eminent risks of an option book (as opposed to individual option positions). [1] http://www.derivativesstrategy.com/magazine/archive/1997/0497fea2.asp http://www.derivativesstrategy.com/magazine/archive/1997/049... [2] https://merage.uci.edu/~jorion/papers/ltcm.pdf https://merage.uci.edu/~jorion/papers/ltcm.pdf

OscarCunningham 9y ago

What Taleb shows is that people should become more willing to bet as they move away from the "absorbing barrier" of having so little money that they have to quit the game. But he phrases this in terms of justifying the fact that people are more willing to bet with "house money" (money that they have already won) than their own. This is clearly wrong because the starting point is always higher than the absorbing barrier. I think Taleb is a bit too eager to criticise others, even when his mathematics isn't actually applicable to the situation.

mjb 9y ago
"A bit too eager to criticize others" is a understatement. Taleb has a lot of interesting things to say, and some of them are even reasonably novel. Unfortunately his general "everybody but me is stupid" approach makes his message much less useful and accessible than it otherwise would be. This is a good example of that problem. I find this really unfortunate, because Taleb's message about systems behavior being dominated by tail behavior, and about the risks systems not being designed to tolerate that behavior, are very interesting and broadly applicable. Unfortunately, the medium makes the message less effective. I often think of Taleb as a sort of counter-example when thinking about how to teach and communicate difficult concepts.
- te_chris 9y ago
  He's such a thin-skinned snowflake. I enjoyed The Black Swan but didn't know much about him as a person. He should give up twitter, or stop reading reviews. His fans are hilarious too: he's created a whole cult of redundant pedants.
  - vvdcect 9y ago
    >whole cult of redundant pedants. aspiring despots
- pfortuny 9y ago
  The long tails and the lack of mean of important distributions is essential. However, we are losing those concepts because of his belligerance. A pity.

root_crontab 9y ago

I see too many of these. Write code to simulate something and obtain an inconclusive version of a result you can simply derive and prove definitively using statistics.

jerf 9y ago

This idea has a lot of legs if you examine it. One of the more interesting points I've heard from Jordan Peterson in one of his criticisms of postmodernism is this: Postmodernism observes that after centuries of trying, we don't seem to have an objective standard for ethics or philosophy (or at least one that we can all agree on). Postmodernism, to the extent that one can refer to the whole movement in a short sentence, then tends to assume that therefore there are no distinctions between moral frames or perspectives, and from there proceeds to go in a different direction and analyzes everything simply in terms of power, because they decided that's the only thing that matters since moralities and philosophies otherwise have no meaning. Don't get too tied up in the details of that summary; I'm well aware of just how brutal that summary is. But the details of the summary aren't what's important; what's important is the observation that there are absorbent barriers in philosophy and especially morality. You can't pursue a morality that results in your death, especially if it results in a quick death. There's some others too, but that's biggest and the most obvious. Civilizational death is another one; more abstract, but also a rich vein of observations. For example, there's a lot more people living people advocating for humanity to be killed off for the planet than dead people advocating for humanity to be killed off for the planet's sake. It is impossible for the living to observe any other outcome. This does not lead us via simple, universally-agreeable philosophical steps to a universally-agreed upon morality. But it does create distinctions between different moralities and philosophies, and once you admit that into the world, it once again becomes valid to study different philosophies and moralities again without having to accept the postmodernistic "throw your hands in the air and give up ever being able to determine anything, and then go study something else instead". It's still nowhere near a mathematically rigorous world by any means, but it's no longer hopeless. (Bonus observation 1: No, this is not simply utilitarianism. Consider utilitarianism as a spectrum of "how concerned am I about 'utility'". Utilitarianism is the idea that we should be very far to the side of considering that, if not considering it solely; on a spectrum from 0 to 1, utilitarianism is that we should be close to or on 1. This observation is the complementary observation that we can not be close to or on 0. But we might still be on, say, 0.5, which is not "utilitarianism" but may be enough to create philosophies that still keep us alive. This observation also does not depend on "valuing" life over death, because it is on a far more primal and brutal level than that. It is the factual observation that if you hit one of these absorbing barriers you are no longer a participant in philosophy, not a normative statement about whether that is or is not a good thing.) (Bonus observation 2: This is the beginning of the path, not the end.)

bluecalm 9y ago

>>So, if you look at the world as repetition of bets, under condition of survival, then mental accounting is not only not irrational but is necessary. Any other strategy would be effectively irrational. No, it's still irrational and it doesn't matter if there is repetition of bets or just one available. Depending on your total net worth, living conditions and values you have there are good bets and bad bets. A good bet is a bet which maximizes expected utility of your money. It changes depending on your net worth of course. It doesn't matter if you have just won or lost (this is mental accounting) it matters what's your total net worth is at given time. >>Actually, what I’m saying is even stronger. I am saying that even if you have the edge, in the presence of the probability of ruin, you will be ruined. Even if you had the edge … If you play long enough. He wouldn't pass 1st year college math course with that one. >>Unless you engage in strategies designed by traders and rediscovered by every single surviving trader, very similar to what we call, something called the Kelly Criterion, which is to play with the house money He doesn't grok what Kelly Criterion is either. Kelly Criterion determines a size of the bet which maximizes utility of money modeled as a logarithmic funciton. That's it. It doesn't matter if there is string of bets available or just one bet. If you have just won or lost doesn't matter either (only your total net worth at given point). >>And this is called, playing with the market money or playing with the house money. It's called being confused about basic math and economic concepts and then criticizing people who worked on those. Typical Taleb: confused, wrong, having no new insights to offer but making up for those with new terms (absorbent barriers, really?) and a lot of words.

cardmagic 9y ago
>> Actually, what I’m saying is even stronger. I am saying that even if you have the edge, in the presence of the probability of ruin, you will be ruined. Even if you had the edge … If you play long enough. > He wouldn't pass 1st year college math course with that one. Seems pretty straightforward to me. Let's say you play a game with an edge where you win 2x your money 99% of the time. But if you lose once, you lose all your money (1% risk of ruin). If you play this game 70 times, you are very likely to end up ruined. It’s a lot like smoking. One cigarette won’t kill you, but add up the probability cigarette after cigarette, pack after pack, year after year and the probability starts to skyrocket.

deleted 9y ago

[deleted]

apo 9y ago

The author quotes Taleb: ...Unless you engage in strategies designed by traders and rediscovered by every single surviving trader, very similar to what we call, something called the Kelly Criterion, which is to play with the house money. ... And later restates: What Taleb said is we should be more aggressive with the house money. AFAICT, the Kelly Criterion has nothing to do with playing with house money. Instead, Kelly tells you how much of your wallet to wager given the payout and probability of winning. The source of the money you stake is irrelevant. Dice don't care whether your wager came from the house or your 401k. For example, in a coin toss biased 60% to heads with a 2x payout for win, you should bet 20% of your wallet on heads and keep doing that no matter which way the flips go (2p - 1 = 2*0.6 - 1 = 0.2). If p ≤ 0.5, don't bet. https://en.wikipedia.org/wiki/Kelly_criterion https://en.wikipedia.org/wiki/Kelly_criterion https://www.youtube.com/watch?v=d4yzXbdq2DA https://www.youtube.com/watch?v=d4yzXbdq2DA Playing this strategy optimizes your return and ensures you can never go bust, thereby missing out on the guaranteed payout over enough bets.

andrewla 9y ago
I believe the point he is making about "house money" and the Kelly Criterion is the size of the bet corresponds to how far ahead you are -- as you get farther ahead, your bets will get larger. The problem with the comparison is that if you have one trader who started with $20, and another with $100, but they both currently have $50, they will both, by the Kelly criterion, be betting the same amount of money, even though once trader is trading with "house money" and the other is not. They're still trading without memory, which is the point that he was trying to refute, as I understand it.
tomp 9y ago
Is he actually arguing that "house money" is different from "your money" or is he just reusing existing terminology? IIRC, the idea of "house money" was invented by earlier researchers who tried to explain why people would bet more after winning. Obviously "keeping score of your wealth" explains the effect just as well as "playing with house money".
- apo 9y ago

njarboe 9y ago

The interesting thing I got out of this analysis is that, if you have a slight edge of 1%, having the constant percentage betting strategy is much better, if you have a large (100,000) number of bets. Having a log scale would be nice to see approximately where the two strategies returns diverge. This got me thinking. One thing that is not discussed is that in real life trading one does not know what percentage advantage one has. Many successful traders rely on subconscious processes for part of their trading strategy that they have no way of examining, but seems to work(sometimes). If the only way to find out what your expected return is(your edge), is to bet and see what happens (maybe this is really the reason one needs "skin in the game") then ramping up your betting when you are winning is a really good idea. When you are losing money it is likely your expected return is negative and you should start scaling back your bets until you find an edge again. It would be interesting to run this code with variable rates of return over time, including negative ones, where one scales the bet size not on your net capital but on (the percentage win on the last n bets)*(capital). I'm sure this is all in some book written in the 18th century as people have been trading in markets for a long time.

danieltillett 9y ago
What a lot of traders do is use 50% of the Kelly limit to cover this risk. At worst by staying under the Kelly limit you reduce your return, while if you exceed it you will blow up at some point.
jbp 9y ago
Don't know about 18th century, but some what similar strategy is already mentioned by Taleb in the interview: Kelly Criterion.
- njarboe 9y ago
  I thought what I was saying was quite a bit different. If one is using the Kelly Criterion, one needs to know what the probability of winning and odds paid for a win. Traders generally don't know these at all and only can find them out by making the trade and seeing what happens. Of course when the Kelly Criterion is known and constant, one can make the optimal bets and get rich, but those situations don't exist in real life (unless there is some kind of monopoly or external force being used to make people take the other (loosing side) of the bet). The iterative thinking of the the Kelly Criterion must be part of a traders mindset, but markets never understood well enough to where this formula can be strictly applied. A bit strange to see Taleb talk about a casino situation to explain his thinking. Elsewhere he mocks such "casino odds" view of the world as very unrealistic an bemoans that such a view will cause one grief if you use those ideas with "skin in the game". ps. I've only read "Anti-Fragile" and some of his blog essays.

ikeboy 9y ago

I believe the response to this is that the actual increased willingness to bet is way higher than could possibly be justified by the paltry amounts won. If e.g. your net worth is 10k, you win 500, and suddenly you're twice as willing to bet 500, something is off.