9 ms·

Kelly here is the only way which is addressing the ruin, other two are (bad) tricks around initially wrong assumptions

kgwgk 6y ago
Their result is not an alternative to expected utility maximization. It is expected (logarithmic) utility maximization.
hntrader 6y ago
In practice, utility theory works well. Poker players adopt a utility function similar to u(x)=x and apply some very basic risk management heuristics (bankroll management) on top in order to handle ergodicity. Their whole thought process is centred on E[u(x)] (E[x]), and they have much more affinity for expected utility theory than the more "correct" Kelly. Professional investors adopt a slightly risk-averse u(x) (not quite ln(x) in my experience) and do just fine with that. Risk of ruin is managed again using simple practical heuristics, such as capping the maximum downside on each decision, and sizing up only when confident (in Kelly-like fashion - but very subjective). That it doesn't explicitly handle ergodicity isn't a huge flaw in practice. It's still a useful (although imperfect) mental model of what's going on in people's brains and offers some practical usefulness. It's also not a wrong assumption technically, because it's not claiming to model such phenomena, its claim is to model the utility of a single discrete choice.
- ReflectedImage 6y ago
  There are some nasty side effects of EUT through. Prospect theory for example shouldn't exist (when you handle the non-ergodicity part of the problem properly the theory vanishes into thin air). EUT + Hacks works but anything built upon of EUT is subject to sudden collapse due to unstable foundations. Ergonomic economics is able putting down stable foundations that other theories can be built upon of.
  - deleted 6y ago
    [deleted]
  - hntrader 6y ago
    EUT should be adjusted to handle ergodicity properly. But the concept of expected utility needs to be the centrepiece of the theory. Kelly, for example, is fatally flawed because it ignores utility: (1) Ruin isn't an absorbing state in most contexts, due to bankrupticy laws, limited liability, relationships, and so on. Ruin is an absorbing state in other contexts. Only utility can capture this difference. (2) Implementing Kelly requires the emotional fortitude of a rock. In practice, it becomes a losing strategy since the practitioner will collapse emotionally and make bad decisions whenever the distribution of the outcome is unknown. (3) Implementing Kelly forgets that investors will redeem capital if the downswing is too severe for them. (4) etc. Only a conceptual framework built around expected utility as a bedrock principle can handle these practical realities, and moreover capture those practical realities empirically.
    - ReflectedImage 6y ago
      "expected utility needs to be the centrepiece of the theory" Fundamentally expected utility is wrong. Kellys is fatally flawed as it's merely one of a whole class of functions that be used, where Kellys happens to be on the aggressive side of things. Ole Peters gives the entire class of the functions that can be used. There is obviously a whole band of less to more aggressive options you can take.
      - hntrader 6y ago
        > Fundamentally expected utility is wrong. Do you say this because EUT currently doesn't handle ergodicity? Why do those two things need to be mutually exclusive? > whole band of less to more aggressive options Right, and which option I pick will be based on utility preference considerations both over the lifecycle of the decision making process as well as over the terminal outcome's distribution. Expected utility is still inextricably part of this. Older people are going to choose low aggression options on their retirement portfolio because the utility consequences of ruin are much different to a 20 year old's. Expected utility is the point. Handling ergocidity just tells us how to get there correctly.

Their result is not an alternative to expected utility maximization. It is expected (logarithmic) utility maximization.

In practice, utility theory works well. Poker players adopt a utility function similar to u(x)=x and apply some very basic risk management heuristics (bankroll management) on top in order to handle ergodicity. Their whole thought process is centred on E[u(x)] (E[x]), and they have much more affinity for expected utility theory than the more "correct" Kelly. Professional investors adopt a slightly risk-averse u(x) (not quite ln(x) in my experience) and do just fine with that. Risk of ruin is managed again using simple practical heuristics, such as capping the maximum downside on each decision, and sizing up only when confident (in Kelly-like fashion - but very subjective). That it doesn't explicitly handle ergodicity isn't a huge flaw in practice. It's still a useful (although imperfect) mental model of what's going on in people's brains and offers some practical usefulness. It's also not a wrong assumption technically, because it's not claiming to model such phenomena, its claim is to model the utility of a single discrete choice.

ReflectedImage 6y ago
There are some nasty side effects of EUT through. Prospect theory for example shouldn't exist (when you handle the non-ergodicity part of the problem properly the theory vanishes into thin air). EUT + Hacks works but anything built upon of EUT is subject to sudden collapse due to unstable foundations. Ergonomic economics is able putting down stable foundations that other theories can be built upon of.
- deleted 6y ago
  [deleted]
- hntrader 6y ago
  EUT should be adjusted to handle ergodicity properly. But the concept of expected utility needs to be the centrepiece of the theory. Kelly, for example, is fatally flawed because it ignores utility: (1) Ruin isn't an absorbing state in most contexts, due to bankrupticy laws, limited liability, relationships, and so on. Ruin is an absorbing state in other contexts. Only utility can capture this difference. (2) Implementing Kelly requires the emotional fortitude of a rock. In practice, it becomes a losing strategy since the practitioner will collapse emotionally and make bad decisions whenever the distribution of the outcome is unknown. (3) Implementing Kelly forgets that investors will redeem capital if the downswing is too severe for them. (4) etc. Only a conceptual framework built around expected utility as a bedrock principle can handle these practical realities, and moreover capture those practical realities empirically.
  - ReflectedImage 6y ago
    "expected utility needs to be the centrepiece of the theory" Fundamentally expected utility is wrong. Kellys is fatally flawed as it's merely one of a whole class of functions that be used, where Kellys happens to be on the aggressive side of things. Ole Peters gives the entire class of the functions that can be used. There is obviously a whole band of less to more aggressive options you can take.
    - hntrader 6y ago
      > Fundamentally expected utility is wrong. Do you say this because EUT currently doesn't handle ergodicity? Why do those two things need to be mutually exclusive? > whole band of less to more aggressive options Right, and which option I pick will be based on utility preference considerations both over the lifecycle of the decision making process as well as over the terminal outcome's distribution. Expected utility is still inextricably part of this. Older people are going to choose low aggression options on their retirement portfolio because the utility consequences of ruin are much different to a 20 year old's. Expected utility is the point. Handling ergocidity just tells us how to get there correctly.