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Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative ﬁnance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game
Zwillman’s death left Manny Kimmel holding a portfolio of businesses, some legitimate and some not, some owned by Kimmel and others apparently in partnership with Zwillman’s estate and/or still other murky entities. Kimmel had an idea for parlaying this wealth. It was going to be the biggest gamble of his life. It involved the stock market. Edward Thorp ONE FRIEND DESCRIBED Edward Oakley Thorp as “the most precise man I have ever met.” This zeal for measurement was evident from earliest youth. It has been claimed that mathematical talent is, ironically, linked with a child being slow to speak. Ed Thorp was born in Chicago on August 14, 1932, and did not utter his first words until he was nearly three. The Thorp family was at a Montgomery Ward department store when a group of people stepped out of an elevator. “Where’s the man gone?” someone asked. “Oh, he’s gone to buy a shirt,” Ed said.
Gambling Times, Aug. 1978, 11–14. Rogers, Everett M. (n.d.). “Claude Shannon’s Cryptography Research During World War II and the Mathematical Theory of Communication.” Roll, Richard (1988). “R2.” Journal of Finance 43:541–66. ———, and Robert J. Shiller (1992). “Comments: Symposium on Volatility in U.S. and Japanese Stock Markets.” Journal of Applied Corporate Finance 5:25–29. Rotando, Louis M., and Edward O. Thorp (1992). “The Kelly Criterion and the Stock Market.” American Mathematical Monthly, Dec. 1992, 922–31. Rubinstein, Mark (1975). “The Strong Case for the Generalized Logarithmic Utility Model as the Premier Model of Financial Markets.” UC Berkeley Research Program in Finance, Working Paper No. 34. ———(1987). “No ‘Best’ Strategy for Portfolio Insurance.” Financial Analysts Journal, Nov.–Dec. 1987. ———(1988).
Kimmel biography: Ruchman 2000 and unpublished interview with Jack Newton; Tudball 2003, 30; Bruck 1994; Thorp, interview. Peter Ruchman interviewed gambler Jack Newton, who knew Kimmel. He sent part of this unpublished material regarding Kimmel to Ed Thorp, who forwarded it to me. Zwillman biography: See Stuart 1985. Chose number with fewest bets: Stuart 1985, 29. Story about Kaplus shooting: Stuart 1985, 42. 40 percent of imported liquor: Stuart 1985, 53. Kimmel won parking lot in crap game: Bruck 1994, 29. Kimmel mortgaged parking lots: Bruck 1994, 32, which quotes Eddie Hand on this. Taught himself calculus, trigonometry, probability: This is from Peter Ruchman’s interview with Jack Newton, some of which was published in Ruchman 2000. Ed Thorp believes that Kimmel had little understanding of math. Birthdays bet, fly on sugar cube rigged with DDT: Thorp, interview. Kimmel let Adonis use parking lot: Bruck 1994, 30.
A Man for All Markets by Edward O. Thorp
3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy low sell high, carried interest, Chuck Templeton: OpenTable, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, compound rate of return, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative ﬁnance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, statistical arbitrage, stem cell, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration
Copyright © 2017 by Edward O. Thorp All rights reserved. Published in the United States by Random House, an imprint and division of Penguin Random House LLC, New York. RANDOM HOUSE and the HOUSE colophon are registered trademarks of Penguin Random House LLC. LIBRARY OF CONGRESS CATALOGING-IN-PUBLICATION DATA Names: Thorp, Edward O., author. Title: A man for all markets : from Las Vegas to Wall Street, how I beat the dealer and the market / Edward O. Thorp. Description: New York : Random House,  | Includes index. Identifiers: LCCN 2016026545| ISBN 9781400067961 | ebook ISBN 9780812998740 Subjects: LCSH: Thorp, Edward O. | Investment advisors—United States—Biography. | Mathematicians—United States—Biography. | Gambling systems. | Investments. | Finance—Mathematical models. Classification: LCC HG4928.5.T54 A3 2017 | DDC 332.6092 [B]—dc23 LC record available at https://lccn.loc.gov/2016026545 randomhousebooks.com Book design by Christopher M.
considerable controversy In addition to Poundstone’s history, mathematically trained readers can study some of the burgeoning modern developments in The Kelly Capital Growth Investment Criterion: Theory and Practice, editors Leonard C. MacLean, Edward O. Thorp, and William T. Ziemba, World Scientific, 2010. As he told The Wall Street Journal “Old Pros Size Up the Game,” by Scott Patterson, Wall Street Journal, March 22, 2008, page A9. Gross left PIMCO in 2014 and went to Janus to manage money. out in Wilmott magazine See “Understanding the Kelly Criterion,” by Edward O. Thorp, Wilmott, May 2008, pp. 57–59, and http://undergroundvalue.blogspot.com/2008/02/notes-from-buffett-meeting-2152008_23.html. Computer simulations The simulations were done by mathematician Art Quaife. CHAPTER 28 stock index fund Why not continue to hold Berkshire?
Review of the International Statistical Institute 37.3 (1969): 273–93. ———. “The Kelly Criterion in Blackjack, Sports Betting, and the Stock Market.” Handbook of Asset and Liability Management, Volume 1, Zenios, Stavros Andrea, and W. T. Ziemba, Editors. Amsterdam: Elsevier, 2006. Wong, Stanford. Professional Blackjack. La Jolla, CA: Pi Yee, 1994. BY EDWARD O. THORP A Man for All Markets Beat the Dealer Beat the Market Elementary Probability The Mathematics of Gambling ABOUT THE AUTHOR EDWARD O. THORP is the author of the bestseller Beat the Dealer: A Winning Strategy for the Game of Twenty-One (Random House 1962, 1966). It presented the first scientific system ever devised for a major casino gambling game and revolutionized the game of blackjack. His book Beat the Market (Random House 1967, co-authored with Sheen T.
The Quants by Scott Patterson
Albert Einstein, asset allocation, automated trading system, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Meriwether, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative ﬁnance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise
Indeed, many of the most important breakthroughs in quant history derived from this obscure, puckish mathematician, one of the first to learn how to use pure math to make money—first at the blackjack tables of Las Vegas and then in the global casino known as Wall Street. Without Thorp’s example, future financial titans such as Griffin, Muller, Asness, and Weinstein might never have converged on the St. Regis Hotel that night in March 2006. Edward Oakley Thorp was always a bit of a troublemaker. The son of an army officer who’d fought on the Western Front in World War I, he was born in Chicago on August 14, 1932. He showed early signs of math prowess, such as mentally calculating the number of seconds in a year, by the time he was seven. His family eventually moved to Lomita, California, near Los Angeles, and Thorp turned to classic whiz kid mischief.
Just look: exotic leveraged vehicles marketed to the masses worldwide, hedge funds gaming their returns, lightning-fast computerized trading robots, predatory ninja algorithms hunting liquidity in dark pools … Here come the quants. Notes 1 ALL IN Simons had pocketed $1.5 billion: Alpha, May 2006. That night at the St. Regis: Several details of the poker event were gleaned from MFA News 2, 1 (Spring 2006). In 1990, hedge funds held $39 billion: Based on data from Hedge Fund Research, a Chicago research group. 2 THE GODFATHER: ED THORP Just past 5:00 A.M.: I conducted numerous interviews with Ed Thorp and exchanged many emails. Many details about Ed Thorp’s blackjack career, including a description of his foray into blackjack in 1961, were found in his colorful book Beat the Dealer: A Winning Strategy for the Game of Twenty-One (Vintage, 1962). Other details were found in the excellent Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone (Hill and Wang, 2005).
Other details were found in the excellent Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone (Hill and Wang, 2005). I confirmed details I used from this book with Thorp. The strategy was from a ten-page article: “Getting a Hand: They Wrote the First Blackjack Book but Never Cashed In,” by Joseph P. Kahn, Boston Globe, February 20, 2008. He’d kept his roulette strategy largely secret: “The Invention of the First Wearable Computer,” by Edward O. Thorp (http://graphics.cs.columbia.edu/courses/mobwear/resources/thorp-iswc98.pdf.) Science-fiction writer Arthur C. Clarke: Voice Across the Sea, by Arthur C. Clarke (HarperCollins, 1975). 3 BEAT THE MARKET On a typical day of desert sun: Much like the blackjack chapter, many details of this chapter derive from interviews with Thorp, Fortune’s Formula, and Thorp’s second book, Beat the Market: A Scientific Stock Market System.
activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative ﬁnance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra
This was the sort of evidence—akin to the crashing and burning of all those high-beta, go-go mutual funds in the late 1960s—bound to fill finance scholars with confidence that their theories were not just helpful approximations but eternal truths. Even though some of those truths were self-fulfilling. The phrase “self-fulfilling prophecy” was coined by sociologist Robert K. Merton.19 Merton also wrote about the vagaries of scientific credit and naming, mainly the fact that the right people often don’t get credit for major discoveries. There was some of that at work with the options formula. Edward O. Thorp, a math professor at the University of California–Irvine, had figured out the mechanics of it back in 1968. But he hadn’t devised a proof of the formula—other than that when he used it, he made money. Plus, he kept it to himself. In scientific terms he didn’t really deserve credit. Some have since argued that Bachelier’s was the true breakthrough on options pricing, and everything else mere embroidery on his theme.
He didn’t see how he could do that anymore, and he got out. BUFFETT’S INVESTORS NEEDED NEW PLACES to put their cash. One of them, neurologist Ralph Waldo Gerard, was dean of the graduate school at the brand-new Irvine campus of the University of California. UC–Irvine was also home to a math professor interested in money management, thereby entwining his remarkable story with that of Buffett. In 1959, as an instructor at MIT, Edward O. Thorp had figured out how to beat the house at blackjack by counting cards. Crucial to his success was an IBM 704 in an MIT basement, which he used to analyze the changing probabilities as cards were removed from the deck. After presenting his findings at the January 1961 meeting of the American Mathematical Association, Thorp was profiled in several newspapers and swamped with mail from would-be gambling partners.
Author of sharp critiques of efficient market finance in the 1980s and early 1990s who went on to be Secretary of Treasury in the Clinton administration and top economic adviser to President Barack Obama. Richard Thaler University of Rochester product who became Daniel Kahneman and Amos Tversky’s first student among economists. Went on to be a founding father of behavioral economics and an influential professor at Chicago’s Business School. Edward Thorp Math professor at UC–Irvine who, after figuring out how to beat the house at blackjack and writing a bestselling book about it, figured out the formula for pricing options before Fischer Black and Myron Scholes did and became a pioneer of computer driven, black-box hedge fund management. Jack Treynor As a consultant at Arthur D. Little in the late 1950s and early 1960s, he devised a capital asset pricing theory that predated and was nearly identical to William Sharpe’s, but didn’t publish it.
The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall
Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative ﬁnance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, Vilfredo Pareto, volatility smile
And by the time he got wind of the raid, Regan already had a lawyer and refused to talk to his partner. The firm hobbled along for another year, but the legal proceedings had ruined its reputation. In 1989, Princeton-Newport Partners closed. Over the course of twenty years, it had average returns of 19% (over 15% after fees) — an unprecedented performance. After Princeton-Newport closed, Thorp took some time off before regrouping to form Edward O. Thorp Associates, his own money management firm. Though he has long since given up managing other people’s money professionally, he still runs the fund today using his own capital. Meanwhile, hundreds of quant hedge funds have opened (and closed), trying to reproduce Princeton-Newport’s success. As the Wall Street Journal put it in 1974, Thorp had ushered in a “switch in money management” to quantitative, computer-driven methods.
“How Does This Prize-Winning Mathematician and Former Code Breaker Rack Up His Astonishing Returns? Try a Little Luck and a Firm Full of Ph.D.s.” Institutional Investor, November 1. Mackay, Charles. 1841. Extraordinary Popular Delusions and the Madness of Crowds. London: Richard Bentley. MacKenzie, Donald. 2006. An Engine, Not a Camera. Cambridge, MA: MIT Press. MacLean, Leonard C., Edward O. Thorp, and William T. Ziemba. 2011. The Kelly Capital Growth Investment Criterion. Singapore: World Scientific Publishing. Maddy, Penelope. 1997. Naturalism in Mathematics. New York: Oxford University Press. — — — . 2001. “Naturalism: Friends and Foes.” Philosophical Perspectives 15: 37–67. — — — . 2007. Second Philosophy. New York: Oxford University Press. Mahwin, Jean. 2005.
The book owes a special debt to John Conheeney, whose thoughts on the history of derivatives markets gave me a toehold to begin from. I am also grateful to the people who agreed to be interviewed for the book, and who helped me make contact with the book’s subjects and their families. Thank you to Doyne Farmer, Pia Malaney, Sally McClenaghan, Joe Murphy, Holly Osborne, Peter Osborne, Lee Smolin, Didier Sornette, Clay Struve, Ed Thorp, and Eric Weinstein. Pia Malaney, Holly Osborne, Melita Osborne, Peter Osborne, Didier Sornette, Ed Thorp, and Eric Weinstein deserve special thanks for reading early drafts of the chapters to which they contributed and offering useful comments for accuracy. Some friends and colleagues, in addition to providing valuable insights along the way, also read earlier drafts and offered comments. In every case, their thoughts helped to improve the book in material ways.
Beat the Market by Edward Thorp
Other books by EDWARD O. THORP Elementary Probability Beat the Dealer Other books by SHEEN T. KASSOUF Evaluation of Convertible Securities A Theory and an Econometric Model for Common Stock Purchase Warrants BEAT THE MARKET A scientific Stock Market System Random House New York BEAT THE MARKET A Scientific Stock Market System Edward O. Thorp, Ph.D. Professor of Mathematics University of California at Irvine Sheen T. Kassouf, Ph.D. Assistant Professor of Economics University of California at Irvine 987 © Copyright, 1967, by E. O. Thorp and S. T. Kassouf All rights reserved under International and Pan-American Copyright Conventions. Published in New York by Random House, Inc., and simultaneously in Toronto, Canada, by Random House of Canada Limited. Library of Congress Catalog Card Number: 67:22624 Manufactured in the United States of America Designed by Betty Anderson Contents INTRODUCTION 3 Chapter 1 A SYSTEM IS BORN 7 First venture into the market.
., 101 Wall Street Journal, 26, 53, 71, 104, 109, 128, 162, 166 Warrant axis, 21 Warrant hedge, 43fn Warrant prices, effect of common on, 18-22 effect of short position on, 129 prediction of, 201, 204 sources of, 107fn Warrant terms, sources for, 107fn Warrants, 15 adjusted, 24-26 attached to bond, 98 best, 77, 79 Canadian, 103, 106, 107, 200-203 choosing warrant situations, 88-89 definition, 15 effect of dilution, 110-111 effect of dividend, 110-111 effect of past price history, 111 exercise price, 16 expiration date, 16 extension of conversion privilege, 137-138 gain from short sales, 37 latent, 145 not traded on NYSE, 71 over-the-counter, 103, 106-107, 201 perpetual, 16 premium, 28 profits from shorting, 37 regional, 103 short selling, 36-39 tables of, 29, 202-203 tax advantage in issuing, 98 terms of, 72 why issued, 16 Warrant-stock diagram, applied, 73-77 construction of, 18-22 “corner,” 151 explained, 18ff zero-profit lines in, 47-49 Western Decalta, 203 Weston (George) Ltd., 107 Where Are the Customers’ Yachts?, 161 White Oil Company, 99 Writer, option, 164 definition, 162 Yield, current, 144 to maturity, 144 Xerox 4s of ‘84, 156-158 Zero-profit line, 80 explained, 47 how to draw, 48, 81 with reverse hedge, 124 Yearly range, 119 ABOUT THE AUTHORS EDWARD O. THORP is the author of the best-seller Beat the Dealer: A Winning Strategy for the Game of TwentyOne, published by Random House in 1962 and in revised form in 1966. It presented the first scientific winning system ever devised for a major casino gambling game. He has also written Elementary Probability (1966) and numerous mathematical papers on probability, game theory, and functional analysis. He completed undergraduate and graduate work at U.C.L.A., receiving the B.A. and M.A. in physics, and the Ph.D. in mathematics in 1958.
Library of Congress Catalog Card Number: 67:22624 Manufactured in the United States of America Designed by Betty Anderson Contents INTRODUCTION 3 Chapter 1 A SYSTEM IS BORN 7 First venture into the market. The market calls: boardrooms and chartists. The “circus”. Fundamentals: the “better” they are, the faster they fall. Textron and Molybdenum. The moment of discovery. Steady profits in bust and boom. 2 WARRANTS: OPTIONS ON THE FUTURE 15 Rediscovery of the system: Ed Thorp under a tree. What is a warrant? Get rich quick? The warrant-stock diagram. The two basic rules relating warrant prices to stock prices. Adjusted warrants and adjusted exercise price. Reading the financial pages. Checking the two rules. The warrant-stock law: predictability in the stock market. 3 SHORT SELLING: PROFITS IN BAD TIMES 33 Short selling. Selling warrants short. Molybdenum warrants and the avalanche effect. 4 THE BASIC SYSTEM Hedging: high profit with low risk.
Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim
activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative ﬁnance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve
Brandon Adams, Gustavo Bamberger, Bill Benter, John Bogle, Rick Bookstaber, Reuven Brenner, Eugene Christiansen, Emanuel Derman, Art Duquette, Dylan Evans, Doyne Farmer, Justin Fox, Kenneth French, Lisa Goldberg, James Grosjean, Ian Hacking, Michael Heneberry, Carey Hobbs, Craig Howe, James McManus, Michael Maubossin, Nick Maughan, Perry Mehrling, Robert Merton, Joe Nocera, John O’Brien, Deborah Pastor, Scott Patterson, William Poundstone, Kevin Rosema, Myron Scholes, James Stoner, Nassim Taleb, Edward Thorp, Whitney Tilson, James Ward, Paul Wilmott, and Bruce Zastera were particularly helpful. The title comes from my daughter, Aviva Pastor. Tiffany Charbonier, Bill Falloon, Stacey Fischkelta, Meg Freeborn, Sharon Polese, and other folks at John Wiley & Sons provided essential feedback and support. Muhammad Cohen edited every word I wrote, and I rarely overrode his corrections. This book is far more readable for his efforts.
If they are small or slow growing, they don’t cause a lot of problems or offer a lot of opportunities. The second reason to discuss exponentials goes back to the 1956 discovery by physicist John Kelly that exponentials trump risk. If you can organize your risk taking to get the optimal level of exponential growth, you end up better off than you can possibly be using any other strategy. Mathematician and hedge fund innovator Edward Thorp named the strategy “fortune’s formula.” In a sense you conquer risk since your outcome is guaranteed to be better than that of someone who avoids risk. It’s not risk if you can’t lose. Kelly’s result was theoretical, and we do not know how to conquer risk completely. But his work has led to sophisticated practical techniques for harnessing the power of exponentials to exploit risk. The last reason to study exponentials is that risk-avoiding people often use them recklessly.
Quants to Wall Street A lot of gambling quants moved to Wall Street in the early 1980s, representing maybe 20 of the 100 or so rocket scientists who arrived around the same time. Other rocket scientists had been floor traders or other kinds of risk takers. What we had in common were quantitative training, a similar view of the world, similar aspirations, and at least several years of experience supporting ourselves with independent risk-taking activities. We also had in common a few books, first among which were Edward Thorp’s Beat the Dealer (Random House, 1962) and Beat the Market (Random House, 1967), the latter written with Sheen Kassouf. Ed was the mathematics professor who analyzed and popularized blackjack card counting, and also beat the house at other casino games. In the mid-1960s he turned to investing and invented or perfected an extraordinary number of what are now the standard hedge fund strategies.
The Perfect Bet: How Science and Math Are Taking the Luck Out of Gambling by Adam Kucharski
Ada Lovelace, Albert Einstein, Antoine Gombaud: Chevalier de Méré, beat the dealer, Benoit Mandelbrot, butterfly effect, call centre, Chance favours the prepared mind, Claude Shannon: information theory, collateralized debt obligation, correlation does not imply causation, diversification, Edward Lorenz: Chaos theory, Edward Thorp, Everything should be made as simple as possible, Flash crash, Gerolamo Cardano, Henri Poincaré, Hibernia Atlantic: Project Express, if you build it, they will come, invention of the telegraph, Isaac Newton, John Nash: game theory, John von Neumann, locking in a profit, Louis Pasteur, Nash equilibrium, Norbert Wiener, p-value, performance metric, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative ﬁnance, random walk, Richard Feynman, Richard Feynman, Ronald Reagan, Rubik’s Cube, statistical model, The Design of Experiments, Watson beat the top human players on Jeopardy!, zero-sum game
The four soldiers also later published a book for nonstatisticians, entitled Playing Blackjack. According to McDermott, it made a total of $28. (Source: Kahn, “Legendary Blackjack Analysts Alive.”) 37It was meant to be a relaxing holiday: Thorp, Edward. Beat the Dealer (New York: Random House, 1962). 38Thorp gradually turned the research: Kahn, “Legendary Blackjack Analysts Alive.” 38He saw it more as an academic obligation: Towle, Margaret. “Interview with Edward O. Thorp.” Journal of Investment Consulting 12, no. 1 (2011): 5–14. 39“It showed that nothing was invulnerable”: Author interview with Bill Benter, July 2013. 39Switching his university campus in Cleveland: Yafa, Stephen. “In the Cards.” The Rotarian, November 2011. 39The decision was to prove extremely lucrative: Ibid. 39his firm was commissioned by the Australian government: Dougherty, Tim. “Horse Sense.”
Fortunately for gamblers, a roulette ball does not spin for an extremely long period of time (although there is an oft-repeated myth that mathematician Blaise Pascal invented roulette while trying to build a perpetual motion machine). As a result, gamblers can—in theory—avoid falling into Poincaré’s second degree of ignorance by measuring the initial path of the roulette ball. They just need to work out what measurements to take. THE RITZ WASN’T THE first time a story of roulette-tracking technology emerged. Eight years after Hibbs and Walford had exploited that biased wheel in Reno, Edward Thorp sat in a common room at the University of California, Los Angeles, discussing get-rich-quick schemes with his fellow students. It was a glorious Sunday afternoon, and the group was debating how to beat roulette. When one of the others said that casino wheels were generally flawless, something clicked in Thorp’s mind. Thorp had just started a PhD in physics, and it occurred to him that beating a robust, well-maintained wheel wasn’t really a question of statistics.
When he was a student, Benter came across a sign in an Atlantic City casino. “Professional card counters are prohibited from playing at our tables.” It wasn’t a particularly effective deterrent. After reading the sign, only one thought came to mind: card counting works. It was the late 1970s, and casinos had spent the previous decade or so clamping down on a tactic they saw as cheating. Much of the blame—or perhaps credit—for the casinos’ losses goes to Edward Thorp. In 1962, Thorp published Beat the Dealer, which described a winning strategy for blackjack. Although Thorp has been called the father of card counting, the idea for a perfect blackjack strategy was actually born in a military barracks. Ten years before Thorp released his book, Private Roger Baldwin had been playing cards with fellow soldiers at the Aberdeen Proving Ground in Maryland. When one of the men suggested a game of blackjack, conversation turned to the rules of the game.
Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle
activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs
Benjamin Graham and David Dodd, Security Analysis: The Classic 1934 Edition (McGraw-Hill, 1996). 2. Edward O. Thorp, “A Mathematician on Wall Street: Bridge with Buffett.” Wilmott Magazine, November 2005, pp. 34–36, www.wilmott.com/pdfs/110329_thorp.pdf. 3. Jonathan Davis, “Buffett on Bridge,” www.buffettcup.com/BuffettonBridge/tabid/69/language/en-GB/Default.aspx. 4. Ibid. 5. Thorp. 6. William Poundstone, Fortune's Formula: The Untold Story of the Scientific Betting System that Beat the Casinos and Wall Street (New York: Hill and Wang, 2005). 7. Scott Patterson, The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It (New York: Crown Business, 2010). 8. Poundstone, p. 148. 9. Poundstone, p. 320. 10. Warren Buffett, “Shareholder Letter,” Berkshire Hathaway, Inc. Annual Report, 1992. 11. Edward O. Thorp and Sheen T. Kassouf, Beat the Market: A Scientific Stock Market System (Random House, 1967). 12.
Finally, in Part Six we build and test our quantitative value model. We study the best way to combine the research we've considered into a cohesive strategy, and then back-test the resulting quantitative value model. CHAPTER 1 The Paradox of Dumb Money “As they say in poker, ‘If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy.'” —Warren Buffett (1987) In the summer of 1968, Ed Thorp, a young math professor at the University of California, Irvine (UCI), and author of Beat the Market: A Scientific Stock Market System (1967), accepted an invitation to spend the afternoon playing bridge with Warren Buffett, the not-yet-famous “value” investor. Ralph Waldo Gerard hosted the game. Gerard was an early investor in Buffett's first venture, Buffett Partners, and the dean of the Graduate School at UCI, where Thorp taught.
This book seeks to take the best aspects from quantitative investment and value investment and to apply them to stock selection and portfolio construction. Such an approach has several important advantages over pure quantitative investment, or pure value investment. We call our approach Quantitative Value Investing. This book describes our philosophy and sets out to describe the state-of-the-art in quantitative value investment techniques. We seek to marry Ed Thorp's quantitative approach to Warren Buffett's value investment philosophy. We focus on the key to both investment styles, which is a valuation of the target security based on imperfect information, and the consistent exploitation of the differential between the valuation and the pricing available in the market. Buffett seeks to determine the value of an equity security through careful fundamental analysis, relying on his vast experience and superior intellect.
Wonderland: How Play Made the Modern World by Steven Johnson
Ada Lovelace, Alfred Russel Wallace, Antoine Gombaud: Chevalier de Méré, Berlin Wall, bitcoin, Book of Ingenious Devices, Buckminster Fuller, Claude Shannon: information theory, Clayton Christensen, colonial exploitation, computer age, conceptual framework, crowdsourcing, cuban missile crisis, Drosophila, Edward Thorp, Fellow of the Royal Society, game design, global village, Hedy Lamarr / George Antheil, HyperCard, invention of air conditioning, invention of the printing press, invention of the telegraph, Islamic Golden Age, Jacquard loom, Jacquard loom, Jacques de Vaucanson, James Watt: steam engine, Jane Jacobs, John von Neumann, joint-stock company, Joseph-Marie Jacquard, land value tax, Landlord’s Game, lone genius, mass immigration, megacity, Minecraft, moral panic, Murano, Venice glass, music of the spheres, Necker cube, New Urbanism, Oculus Rift, On the Economy of Machinery and Manufactures, pattern recognition, peer-to-peer, pets.com, placebo effect, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, QWERTY keyboard, Ray Oldenburg, spice trade, spinning jenny, statistical model, Steve Jobs, Steven Pinker, Stewart Brand, supply-chain management, talking drums, the built environment, The Great Good Place, the scientific method, The Structural Transformation of the Public Sphere, trade route, Turing machine, Turing test, Upton Sinclair, urban planning, Victor Gruen, Watson beat the top human players on Jeopardy!, white flight, white picket fence, Whole Earth Catalog, working poor, Wunderkammern
“It should demonstrate”: J. M. Graetz, “The Origin of Spacewar!,” Creative Computing, August 1981, www.wheels.org/spacewar/creative/SpacewarOrigin.html. “The game of Spacewar!”: Stewart Brand, “Spacewar!,” Rolling Stone, December 7, 1972, www.wheels.org/spacewar/stone/rolling_stone.html. “Using data from the American Ephemeris”: Graetz, “The Origin of Spacewar!” “mechanically well made”: Edward O. Thorp, “Wearable Computers,” Digest of Papers, Second International Symposium on. 1998. “It had perhaps a hundred thousand”: Ibid. “As we worked and during”: Ibid. “The computer’s techniques”: Ken Jennings, “My Puny Human Brain,” Slate, Newsweek Interactive Co. LLC, February 2012. Chapter 6. Public Space “Someone might play”: Leopold S. Launitz-Schurer, “Slave Resistance in Colonial New York: An Interpretation of Daniel Horsmanden’s New York Conspiracy,” Phylon (1960), 144.
A look of alarm passed across her face as she noticed a wiry appendage protruding from his ear, like the antennae of an “alien insect,” as the man would later describe it. Seconds later, he was gone. The mysterious stranger at the roulette table was not, contrary to appearances, a criminal or a mafioso; he was not even, technically speaking, cheating at the game—although years later his secret technique would be banned by the casinos. He was, instead, a computer scientist from MIT named Edward Thorp, who had come to Vegas not to break the bank but rather to test a brand-new device: the very first wearable computer ever designed. Thorp had an accomplice at the roulette table, standing unobserved at the other end, pretending not to know his partner. He would have been unrecognizable to the average casino patron, but he was in fact one of the most important minds of the postwar era: Claude Shannon, the father of information theory and one of the key participants in the invention of digital computers.
See also technology Deep Blue, 193–94 digital simulations that trigger emotions, 184–85 Expensive Planetarium, 217–18 and games, 230–31 global collaboration, 201–202, 217–20 Hingham Institute, 215–16 IBM, 193–94, 227–28, 230, 280 “low-rent” vs. “high-rent” product development, 220 Minecraft, 201 networks of the early 1990s, 170 PDP-1, 215–16 for purposes of non-scientific pursuits, 219–20 Claude Shannon, 221–26, 223 software, development of, 215–19 Spacewar! 216–20, 218 “Spacewar: Fanatic Life and Symbolic Death Among the Computer Bums,” 219–20 Edward Thorp, 221–27 Turing Test, 227 Type 20 Precision CRT, 215–16, 218 Watson, 228–30 wearable computers, 221, 225–26 Conflagration of Moscow, The, 164–66 Conroy, David, 241 Constantine the African, 134 Cooperstown, New York, 199–200 Copland, Aaron, 97 Cortés, Hernan, 213 cotton appealing texture of, 26–28 British East India Company, 28 “Calico Madams,” 28 chintz and calico, vivid colors of, 26–27, 27 described by John Mandeville, 26 economic fears regarding the import of, 28–29 European desire for, 29–31 importing from India, 26, 28 inventions to aid in the production of fabric, 29, 30 slavery to produce, 34–36 Cox, James, 14 criminology physiological causes vs. environmental causes, 47–48 Cristofori, Bartolomeo, 88 cultural diversity in modern times, 274–76 Darrow, Charles, 198–99 Darwin, Charles, 269–70 Das Kapital (Marx), 153–54 De Coitu (Constantine the African), 134 Defoe, Daniel, 24, 28 Dell, Michael, 216 demand for cotton fabrics, 29–31, 34–36 “desire of Novelties,” 30–31 for experiencing the world through exotic spices, 137–38 for new experiences and surprises, 61 for rubber, 214 democratizing force of fashion, 38–40 department stores as alternatives to chapels and cathedrals, 43–44 Au Bonheur des Dames (Zola), 43–44 Le Bon Marché, 41–46, 45 commercial profitability of wandering shoppers, 41–44 credit, extending, 44 “department-store disease,” 47 haggling, elimination of, 44 influence of Aristide Boucicaut, 40, 41–42, 48–49 origins of, 41 sensory overload and disorientation, 41–42 shoplifting, 46–49 De Smet, Pieter, 137 Devil’s Milk, The (Tully), 214 Devlin, Keith, 208–209 Diamond, Jared, 141, 143 dice astragali, 205–206, 208–209 and probability, 206–207, 209 to speed up the game of chess, 203 standardized design of, 209 Dickens, Charles, 163 Digital Revolution artistic origins of the, 83 Spacewar!
Predator's Ball by Connie Bruck
corporate raider, diversified portfolio, Edward Thorp, financial independence, fixed income, Irwin Jacobs, mortgage debt, offshore financial centre, paper trading, profit maximization, The Predators' Ball, yield management, Yogi Berra, zero-coupon bond
Somewhat rueful about having made that losing trade, Shenkman calculated Milken’s profit (as $635,500) and remarked, “People work a lifetime and never make that kind of money, and Mike made it in a three-minute phone conversation.” Finally, from the line of questioning at this deposition, it appears that Columbia Savings, First Executive, and the Princeton-Newport Limited Partnership (controlled by James Regan and Edward Thorp, Milken’s partners in Belvedere Securities, the Chicago brokerage firm in which he had the majority interest) may have done well, along with Milken, on the Caesars World exchange. Milken was asked whether he had had any conversation about the Caesars World bonds with Tom Spiegel, Fred Carr, James Regan or Edward Thorp between the time of his Caesars meeting and the announcement of the exchange offer about two weeks later. Milken testified that he had not. He was also asked if he was familiar with a sale of Caesars World bonds from the Drexel account of Prudential’s high-yield fund (decidedly not an inner-circle member) to the Columbia Savings account, about a week before the exchange offer was announced.
Probably one of the more lucrative of these investment partnerships was one formed to create a Chicago brokerage firm named Belvedere Securities, in early 1981. Belvedere was somewhat unusual among Milken’s investment partnerships in that it had people participating in it who were not members of Drexel. At the outset, Belvedere Securities had among its general partners two money managers whom Milken had done business with since the early seventies, James Regan and Edward Thorp. Regan and Thorp controlled a number of entities, including an arbitrage fund, Princeton-Newport Partners, and Oakley-Sutton Management. Three other general partners of Belvedere had all been previously associated with a Regan-Thorp group. The sixth general partner, which contributed 75–100 percent of the firm’s capital, was Milow Corporation (seemingly standing for Michael-Lowell). Lowell Milken was president, director and shareholder of Milow, and Richard Sandler was vice-president, director and shareholder.
If true, this would have given Atlantic Capital added motivations (beyond the high yield of the bonds) for being probably the single largest subscriber to the junk bonds in the 1985 takeovers; it would have had a powerful interest in the deals’ going through, since it was a shareholder in the target company, and it would also be repaying the favors of Drexel’s tips. As the investigation continued, the government would become interested in another satellite group with which Milken had done business, the Regan-Thorp entities. James Regan and Edward Thorp and their associates had been Milken’s partners at least since the Treasuries-stripping days of Dorchester Government Securities and Belvedere Securities, and they had been a focus of SEC interest in the 1985 investigation into the trading of Caesars World securities. In December 1987, federal agents would raid and confiscate more than sixty boxes of documents and business records going back to January 1984 from three firms which operated from the same address in Princeton, New Jersey—Princeton-Newport Arbitrage Partners, Englewood Partners and the Oakley-Sutton Management Corporation.
Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel
Albert Einstein, asset allocation, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam, zero-sum game
Cooperman received his MBA from Columbia University and his undergraduate degree from Hunter College. 4. Commencement address given before the graduating class of 1989, University of Georgia, June 17, 1989. 5. Gibbons Burke, Managing Your Money. Active Trader (July 2000). 6. Mark Rzepczynski, Portfolio Diversification: Investors Just Don’t Seem to Have Enough. JWH Journal. 7. Jack Reerink, The Power of Leverage. Futures, Vol. 24, No. 4 (April 1995). 8. Edward O. Thorp, The Mathematics of Gambling. Hollywood, CA, 1984. 9. Larry Harris, Trading and Exchanges: Market Microstructure for Practitioners. New York: Oxford University Press, 2003. 10. Going Once, Going Twice. Discover (August 2002), 23. 11. Jim Little, Sol Waksman, A Perspective on Risk. Barclay Managed Futures Report. 12. Craig Pauley, How to Become a CTA. Based on Chicago Mercantile Exchange Seminars, 1992–1994.
I am also indebted to the following authors whose works continue to be treasure troves of information and insight: Morton Baratz, Peter Bernstein, Clayton Christensen, Jim Collins, Jay Forrester, Tom Friedman, Gerd Gigerenzer, Daniel Goleman, Stephen Jay Gould, Alan Greenberg, Larry Harris, Robert Koppel, Edwin Lefevere, Michael Lewis, Jesse Livermore, Roger Lowenstein, Acknowledgments Ludwig von Mises, Lois Peltz, Ayn Rand, Jack Schwager, Denise Shekerjian, Robert Shiller, Van Tharp, Edward Thorp, Peter Todd, Brenda Ueland, and Dickson Watts. This book could only have come to fruition with the editorial guidance of Jim Boyd at FT Press, as well as the able assistance and attention to detail of Dennis Higbee. I also want to thank Donna Cullen-Dolce, Lisa Iarkowski, Stephen Crane, John Pierce, and Lucy Petermark. To Paul Donnelly at Oxford University Press, I owe a special debt of gratitude for seeing potential in my initial proposal—even though he passed!
Alex's Adventures in Numberland by Alex Bellos
Andrew Wiles, Antoine Gombaud: Chevalier de Méré, beat the dealer, Black Swan, Black-Scholes formula, Claude Shannon: information theory, computer age, Daniel Kahneman / Amos Tversky, Edward Thorp, family office, forensic accounting, game design, Georg Cantor, Henri Poincaré, Isaac Newton, Myron Scholes, pattern recognition, Paul Erdős, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Feynman, Richard Feynman, Rubik’s Cube, SETI@home, Steve Jobs, The Bell Curve by Richard Herrnstein and Charles Murray, traveling salesman
John Kelly Jr was a Texan mathematician who outlined his famous gambling strategy formula in a 1956 paper, and when Ed Thorp put it into practical use at the blackjack table, the results were striking. ‘As one general said, you get there firstest with the mostest.’ With small edges and judicious money management, huge returns could be achieved. I asked Thorp which method was more important to making money at blackjack – card-counting or using the Kelly criterion. ‘I think the consensus after decades of examining this question,’ he replied, ‘is that the betting strategies may be two thirds or three quarters of what you’re going to get out of it, and playing strategy is maybe a third to a quarter. So, the betting strategy is much more important.’ Kelly’s strategy would later help Thorp make more than $80 billion dollars on the financial markets. Ed Thorp announced his card-counting system in his 1962 book Beat the Dealer.
Events that are random under one set of information might well become non-random under a greater set of information. This is turning a maths problem into a physics one. A coin flip is random because we don’t know how it will land, but flipped coins obey Newtonian laws of motion. If we knew exactly the speed and angle of the flip, the density of the air and any other relevant physical data, we would be able to calculate exactly the face on which it would land. In the mid 1950s a young mathematician named Ed Thorp began to ponder what set of information would be required to predict where a ball would land in roulette. Thorp was helped in his endeavour by Claude Shannon, his colleague at the Massachusetts Institute of Technology. He couldn’t have wished for a better co-conspirator. Shannon was a prolific inventor with a garage full of electronic and mechanical gadgets. He was also one of the most important mathematicians in the world, as the father of information theory, a crucial academic breakthrough that led to the development of the computer.
In 1956 an article was published in an obscure statistics journal that claimed to have devised a playing strategy that gave the house an advantage of just 0.62 percent. After reading the article, Thorp learned the strategy and tested it during a vacation trip to Vegas. He discovered that he lost his money much slower than the other players. He decided he would begin to think deeply about blackjack, a decision that would change his life. Ed Thorp is now 75 but I suspect he doesn’t look that different from how he looked half a century ago. Slim, with a long neck and concise features, he has a clean-cut college-boy haircut, unpretentious glasses, and a calm, upright posture. After returning from Vegas, Thorp reread the journal article. ‘I saw right away, within a couple of minutes, how you could almost certainly beat this game by keeping track of the cards that were played,’ he remembered.
Dealers of Lightning by Michael A. Hiltzik
Apple II, Apple's 1984 Super Bowl advert, beat the dealer, Bill Duvall, Bill Gates: Altair 8800, computer age, creative destruction, Douglas Engelbart, Dynabook, Edward Thorp, El Camino Real, index card, Jeff Rulifson, John Markoff, Joseph Schumpeter, Marshall McLuhan, Menlo Park, oil shock, popular electronics, Robert Metcalfe, Ronald Reagan, Silicon Valley, speech recognition, Steve Ballmer, Steve Crocker, Steve Jobs, Steve Wozniak, Steven Levy, Stewart Brand, the medium is the message, Vannevar Bush, Whole Earth Catalog, zero-sum game
You can 145 maybe convince them that something’s of interest and importance, but you cannot tell them what to do.” On the other hand, you can find a way for them to tell each other. The uncompromising give-and-take of Taylor’s ARPA contractor meetings lent itself to reproduction at PARC in the form of “Dealer.” The name derived from the book Beat the Dealer, by Edward O. Thorp, an MIT math professor who had developed a surefire system for winning at blackjack—“beating the dealer”—by counting the high-and low-value cards dealt out in hands. (This truly effective system would make the unassuming Ed Thorp the godfather of professional blackjack card-counting.) Taylor was not much of a blackjack buff. What interested him about Beat the Dealer was its compelling metaphor of a doughty individual fielding the challenge of a group of trained and determined adversaries. In casino blackjack the dealer plays against everyone at the table.
But he knew about BS from a television special he had seen on cable: a framework of proper plays based on what the dealer was showing, developed first—in a flawed but thorough form—by four army engineers who played tens of thousands of hands and published their results in the September 1956 edition of the Journal of the American Statistical Association. BS was then thoroughly reworked in the early sixties by a UCAL and visiting MIT math professor named Edward Thorp, then tweaked numerous times over the years by experts with access to IBM computers. Kevin had never bothered to study basic strategy because he gambled only occasionally—and he wasn’t really sure how much of a difference it made, anyway. Was skill really that much of a factor in blackjack? Didn’t it all boil down to a matter of luck? Martinez obviously took basic strategy extremely seriously.
Micky waved his hands again, tabling the question for later. “Kevin, we count cards. Are you familiar with the practice?” Kevin nodded. “I’ve done a bit of reading on the subject.” “Good, good. So you must have heard of the hi-lo method of counting, right?” Kevin nodded again. His memory wasn’t photographic like some other MIT kids he knew, but he retained things fairly well. He knew that the hi-lo method dated back to 1962 and the publication of Edward Thorp’s groundbreaking best-seller Beat the Dealer. In the book, Thorp outlined a simple counting method that allowed players to keep rough track of the number of high cards left in an unplayed shoe. Instead of counting individual cards, players simply kept track of a single number, the running count. This number was added to every time a low card came out of the deck, and subtracted from every time a high card hit the table.
Or if black comes up three times on the roulette wheel, how have the odds of black coming up again changed? The simple and definitive answer is that in either case, the odds haven’t changed one bit. Again, blackjack is the only popular casino game where what you see affects what you are going to see. This fact, and this fact alone, makes blackjack beatable. It’s just a matter of figuring out how best to take advantage of the game’s continuous probability. To this end, in 1963, MIT professor Edward Thorp did simulations on the relative effect that each card has on the player’s chances of winning. What he found was that when many low cards remained in the deck (sevens and below), the odds were in the dealer’s favor. Contrarily, when there were many high cards remaining (nines, tens, face cards, and aces), the odds shifted to the player. Over the years, many different counting systems have been developed based on his work—but the simple rule of thumb preaches that low cards remaining in the deck are bad for the player, and high cards are good.
algorithmic trading, asset allocation, automated trading system, backtesting, Black Swan, Brownian motion, business continuity plan, compound rate of return, Edward Thorp, Elliott wave, endowment effect, fixed income, general-purpose programming language, index fund, John Markoff, Long Term Capital Management, loss aversion, p-value, paper trading, price discovery process, quantitative hedge fund, quantitative trading / quantitative ﬁnance, random walk, Ray Kurzweil, Renaissance Technologies, risk-adjusted returns, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, systematic trading, transaction costs
Is there anything common between managing a $100 million portfolio and managing a $100,000 portfolio? My contention is that it is much more logical and sensible for someone to become a profitable $100,000 trader before xi P1: JYS fm JWBK321-Chan xii September 24, 2008 13:43 Printer: Yet to come PREFACE becoming a profitable $100 million trader. This can be shown to be true on many fronts. Many legendary quantitative hedge fund managers such as Dr. Edward Thorp of the former Princeton-Newport Partners (Poundstone, 2005) and Dr. Jim Simons of Renaissance Technologies Corp. (Lux, 2000) started their careers trading their own money. They did not begin as portfolio managers for investment banks and hedge funds before starting their own fund management business. Of course, there are also plenty of counterexamples, but clearly this is a possible route to riches as well as intellectual accomplishment, and for someone with an entrepreneurial bent, a preferred route.
A OPTIMAL CAPITAL ALLOCATION AND LEVERAGE Suppose you plan to trade several strategies, each with their own expected returns and standard deviations. How should you allocate capital among them in an optimal way? Furthermore, what should be the overall leverage (ratio of the size of your portfolio to your 95 P1: JYS c06 JWBK321-Chan September 24, 2008 13:57 96 Printer: Yet to come QUANTITATIVE TRADING account equity)? Dr. Edward Thorp, whom I mentioned in the preface, has written an excellent expository article on this subject in one of his papers (Thorp, 1997), and I shall follow his discussion closely in this chapter. (Dr. Thorp’s discussion is centered on a portfolio of securities, and mine is constructed around a portfolio of strategies. However, the mathematics are almost identical.) Every optimization problem begins with an objective.
Frequently Asked Questions in Quantitative Finance by Paul Wilmott
Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, quantitative trading / quantitative ﬁnance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond
The methodology is used in the evaluation of multiple integrals among other things. These ideas would find a use in finance almost three decades later. See Sobol’ (1967), Faure (1969), Hammersley and Handscomb (1964), Haselgrove (1961) and Halton (1960). Figure 1-1: They may not look like it, but these dots are distributed deterministically so as to have very useful properties. 1968 Thorp Ed Thorp’s first claim to fame was that he figured out how to win at casino Blackjack, ideas that were put into practice by Thorp himself and written about in his best-selling Beat the Dealer, the “book that made Las Vegas change its rules.” His second claim to fame is that he invented and built, with Claude Shannon, the information theorist, the world’s first wearable computer. His third claim to fame is that he was the first to use the ‘correct’ formulæ for pricing options, formulæ that were rediscovered and originally published several years later by the next three people on our list.
Paul Wilmott On Quantitative Finance by Paul Wilmott “Paul Wilmott On Quantitative Finance, Second Edition, is even better than his unsurpassed First Edition. He combines the insights of an incisive theorist with his extensive practical experience. His teaching style is clear and entertaining. I recommend the book to everyone in the ‘quant’ community, from beginner to expert, both for learning and for reference.” Ed Thorp Publisher John Wiley & Sons Publication date 2006 Format Hardback, three volumes in slip case, + CD ISBN 0470018704 A research-level book containing the tried and trusted techniques, the analysis of models and data, and cutting-edge material. Contains models and research that cannot be found in other textbooks. Advanced Modelling in Finance Using Excel and VBA by Mary Jackson and Mike Staunton Publisher John Wiley & Sons Publication date 2001 Format Hardback + CD ISBN 0471499226 The book adopts a step-by-step approach to understanding the more sophisticated aspects of Excel macros and VBA programming, showing how these programming techniques can be used to model and manipulate financial data, as applied to equities, bonds and options.
Age of Context: Mobile, Sensors, Data and the Future of Privacy by Robert Scoble, Shel Israel
Albert Einstein, Apple II, augmented reality, call centre, Chelsea Manning, cloud computing, connected car, Edward Snowden, Edward Thorp, Elon Musk, factory automation, Filter Bubble, Google Earth, Google Glasses, Internet of things, job automation, John Markoff, Kickstarter, lifelogging, Marc Andreessen, Mars Rover, Menlo Park, Metcalfe’s law, New Urbanism, PageRank, pattern recognition, RFID, ride hailing / ride sharing, Robert Metcalfe, Saturday Night Live, self-driving car, sensor fusion, Silicon Valley, Skype, smart grid, social graph, speech recognition, Steve Jobs, Steve Wozniak, Steven Levy, Tesla Model S, Tim Cook: Apple, urban planning, Zipcar
About 2.7 billion people are now nodes on the global network, and while it sounds strange, that connectedness empowers each of us. What Started in Vegas… Where wearables are concerned, Moore’s miniaturization is extremely important. If they don’t get small enough to be unobtrusive, people won’t wear them. Small was fundamental to the colorful story of how wearable computers were developed. Edward O. Thorp, an MIT professor whose specialty was mathematical probability, had invented a successful clandestine system for counting cards and winning big at blackjack tables. Growing bored, he took on the larger challenge of predicting the number where a ball spinning on a roulette wheel would land. He devised a clever system that he concealed from the scrutiny of Mob-controlled security guards in Las Vegas casinos.
Hedge Fund Market Wizards by Jack D. Schwager
asset-backed security, backtesting, banking crisis, barriers to entry, beat the dealer, Bernie Madoff, Black-Scholes formula, British Empire, Claude Shannon: information theory, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, Edward Thorp, family office, financial independence, fixed income, Flash crash, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, quantitative easing, quantitative trading / quantitative ﬁnance, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve
Contents Foreword Preface Acknowledgments Part One: Macro Men Chapter 1: Colm O’Shea Addendum: Ray Dalio’s Big Picture View Chapter 2: Ray Dalio Chapter 3: Larry Benedict Chapter 4: Scott Ramsey Chapter 5: Jaffray Woodriff Part Two: Multistrategy Players Chapter 6: Edward Thorp Chapter 7: Jamie Mai Chapter 8: Michael Platt Part Three: Equity Traders Chapter 9: Steve Clark Chapter 10: Martin Taylor Chapter 11: Tom Claugus Chapter 12: Joe Vidich Chapter 13: Kevin Daly Chapter 14: Jimmy Balodimas Chapter 15: Joel Greenblatt Conclusion Epilogue Appendix A Appendix B About the Author Index Other Books by Jack D. Schwager A Complete Guide to the Futures Markets: Fundamental Analysis, Technical Analysis, Trading, Spreads, and Options Getting Started in Technical Analysis Market Wizards: Interviews with Top Traders The New Market Wizards: Conversations with America’s Top Traders Stock Market Wizards: Interviews with America’s Top Stock Traders Schwager on Futures: Fundamental Analysis Schwager on Futures: Managed Trading Myths & Truths Schwager on Futures: Technical Analysis Study Guide to Accompany Fundamental Analysis (with Steven C.
Although segmenting the data to reserve unseen data for testing is a necessary condition to avoid misleading results, it is not a sufficient condition as Woodriff goes on to explain. 7In 2011, QIM changed the exact calculation it used to reduce leverage during periods of poor performance, but the new formulation was similar in both conceptual and practical terms. It is, therefore, simpler to talk about their leverage reduction as one process. Part Two MULTISTRATEGY PLAYERS Chapter 6 Edward Thorp The Innovator Can the markets be beat? Not unless you are lucky, according to proponents of the efficient market hypothesis (EMH), which assumes that the markets discount all known information and immediately reflect all new information. What about traders who have achieved exceptional track records including some of those profiled in this book? EMH believers have a ready response, which is a variant of the popular Shakespearean monkey argument—that is, if you have enough monkeys randomly striking keyboard keys (they have recently traded in their typewriters for PCs), one of them will eventually type Hamlet.
See Options QE2 (quantitative easing) Quadrant conceptualization Quantitative Foundation Quantitative Investment Management (QIM) Ramsey, Scott Random Character of Stock Prices (Cootner) Recessions vs. deleveragings Regan, James Related market price actions Relative Strength Index (RSI) Reminiscenses of a Stock Operator Research in Motion Ltd. (RIMM) Return on capital Reversal vs. correction Ridgeline Partners Rights issues Risk and volatility Risk arbitrage Risk management Edward Thorp Jaffray Woodriff Joe Vidich Larry Benedict Martin Taylor Michael Platt Thomas Claugus Risk vs. volatility RMH Warrants and Low Price Stock Survey (Fried) Rock Tenn Rohm & Haas Roulette system Russian financial crisis of 1998 Schwager, Zachary Schwartz, Marty Secondary variables Sentiment Seykota, Ed Shannon, Claude Sharpe ratio Shaw, David Short-term trading Silver Singer, Paul Slavin, Robert Société Générale Solvency vs. liquidity Soros, George South Korean stock market Soviet Union.
Albert Einstein, back-to-the-land, Black Swan, business climate, Claude Shannon: information theory, Clayton Christensen, complexity theory, corporate governance, cuban missile crisis, Edward Thorp, horn antenna, Hush-A-Phone, information retrieval, invention of the telephone, James Watt: steam engine, Karl Jansky, knowledge economy, Leonard Kleinrock, Metcalfe’s law, Nicholas Carr, Norbert Wiener, Picturephone, Richard Feynman, Richard Feynman, Robert Metcalfe, Sand Hill Road, Silicon Valley, Skype, Steve Jobs, Telecommunications Act of 1996, traveling salesman, uranium enrichment, William Shockley: the traitorous eight
Shannon papers, Library of Congress. 25 Baker was particularly aware of the late-in-life financial travails of Lee De Forest, the inventor of the vacuum tube. Baker told his colleagues that he never wanted such a fate to befall someone like Shannon. 26 Shannon also believed a smart gambler could take advantage of certain inefficiencies in gaming systems, an idea that led him to travel to various Nevada casinos around this time with a mathematician and investor named Ed Thorp. Their intent was to beat the house in roulette and cards. Many of these exploits are detailed in William Poundstone’s book Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street (New York: Hill & Wang, 2005). 27 Arthur Lewbel, author interview. 28 Claude Shannon, “Scientific Aspects of Juggling,” in Collected Papers, edited by N. J. A. Sloane and Aaron D.
And for those wishing to get more of a flavor for Shannon’s life and thought process, I suggest watching the engaging thirty-minute documentary “Claude Shannon: Father of the Information Age,” which is available for viewing on YouTube. I likewise suggest Googling “The Essential Message,” an unpublished MIT thesis on Shannon by Erico Marui Guizzo, which is an insightful look into how he created information theory. Finally, no list of books on Shannon would be complete without Fortune’s Formula, William Poundstone’s entertaining narrative of how in the 1960s Shannon and his friend Ed Thorp tried to beat the Las Vegas casinos and Wall Street. John Pierce wrote many technical books that are still available through used booksellers; with Mike Noll, he also wrote Signals, a useful and accessible introduction to the science of communications. Alas, one of Pierce’s most captivating pieces of writing was My Career as an Engineer, an autobiography (unpublished in the United States) that he wrote—very quickly, I’m sure—for a small Japanese publisher upon receiving the Japan Prize in 1985.
Alan Turing: On Computable Numbers, with an Application to the Entscheidungsproblem, Albert Einstein, Any sufficiently advanced technology is indistinguishable from magic, Claude Shannon: information theory, conceptual framework, Edward Thorp, Fellow of the Royal Society, finite state, four colour theorem, Georg Cantor, Grace Hopper, Isaac Newton, John von Neumann, knapsack problem, New Journalism, Pierre-Simon Laplace, reversible computing, Richard Feynman, Richard Feynman, Schrödinger's Cat, Steve Jobs, Steve Wozniak, thinkpad, Thomas Bayes, Turing machine, Turing test, V2 rocket
Interestingly, however, and in contradiction to his Omni declaration of “no interest in money”—a sentiment he repeated in a 1990 Scientific American profile (“I’ve always pursued my interests without much regard to financial value”)—at MIT he did develop a strong interest in making money. More technically, in what is called portfolio management, the sort of activity that is the heart and soul of pension and mutual funds. At first ignored by financial professionals, Shannon’s ideas (along with those of his Bell Labs colleague John L. Kelly Jr. and the mathematician Ed Thorpe) have today been enthusiastically embraced. The Transactions on Information Theory began publishing papers on portfolio theory in the 1980s, and many PhDs in information theory have since found employment with Wall Street investment firms. Shannon himself became wealthy by applying his ideas to his personal finances, a story you can read at length in the 2005 book by William Poundstone, Fortune’s Formula.
Any sufficiently advanced technology is indistinguishable from magic, Apple II, back-to-the-land, beat the dealer, Bill Duvall, Bill Gates: Altair 8800, Buckminster Fuller, California gold rush, card file, computer age, computer vision, conceptual framework, cuban missile crisis, Donald Knuth, Douglas Engelbart, Douglas Engelbart, Dynabook, Edward Thorp, El Camino Real, Electric Kool-Aid Acid Test, general-purpose programming language, Golden Gate Park, Hacker Ethic, hypertext link, informal economy, information retrieval, invention of the printing press, Jeff Rulifson, John Markoff, John Nash: game theory, John von Neumann, Kevin Kelly, knowledge worker, Mahatma Gandhi, Menlo Park, Mother of all demos, Norbert Wiener, packet switching, Paul Terrell, popular electronics, QWERTY keyboard, RAND corporation, RFC: Request For Comment, Richard Stallman, Robert X Cringely, Sand Hill Road, Silicon Valley, Silicon Valley startup, South of Market, San Francisco, speech recognition, Steve Crocker, Steve Jobs, Steve Wozniak, Steven Levy, Stewart Brand, Ted Nelson, Thorstein Veblen, Turing test, union organizing, Vannevar Bush, Whole Earth Catalog, William Shockley: the traitorous eight
Years later, however, when people would ask about the inventive ideas in Smalltalk, Ingalls would joke, “Well, where do you think these ideas came from?!” Ingalls demonstrated the new feature to one of the large weekly meetings of the PARC researchers in the fall of 1974. The gatherings were known as “Dealers” and had been instituted by Taylor, who took the name from the book Beat the Dealer by Edward O. Thorp, the MIT professor who had developed a system for winning at blackjack. Taylor was taken by the image of a nerdy math professor beating the house. The meetings became forums for both technical presentations and a kind of group interview system for job candidates. The demonstration of BitBlt had a dramatic impact both inside and outside of Kay’s group. One person who watched the demonstration was Don Wallace.
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel
3Com Palm IPO, accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond
Such an expectation is likely to drive interest rates up by about 5 percentage points to compensate investors for holding fixed-dollar-obligation bonds whose purchasing power will be adversely affected by greater inflation. Other things being the same, this should make stock prices fall. But with higher expected inflation, investors may reasonably project that corporate earnings and dividends will also increase at a faster rate, causing stock prices to rise. A fuller discussion of inflation, interest rates, and stock prices is contained in chapter 13. * Edward O. Thorp actually did find a method to win at blackjack. Thorp wrote it all up in Beat the Dealer. Since then, casinos switched to the use of several decks of cards to make it more difficult for card counters and, as a last resort, they banished the counters from the gaming tables. * If such a regularity was known to only one individual, he would simply practice the technique until he had collected a large share of the marbles.
How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter
Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative ﬁnance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional
Conventional finance implausibly assumes that each person has a utility function and seeks to maximize it. Normative portfolio theory is concerned with the properties of utility functions and prescribes utility functions that achieve specified long-term goals such as maximizing the expected rate of compound return. For an excellent discussion, JWPR007-Lindsey May 18, 2007 356 11:41 note s see Edward O. Thorp: “Portfolio Choice and the Kelly Criterion,” reprinted in W. T. Ziemba & R. G.Vickson (eds.): Stochastic Optimization Models in Finance, Academic Press, 1975. 3. Myron J. Gordon: Finance, Investment and Macroeconomics: The Neoclassical and a Post Keynesian Solution (London: Edward Elgar, 1994). 4. “You see, Daddy didn’t bake the cake, and Daddy isn’t the one who gets to eat it. But he gets to slice the cake and hand it out.
3D printing, 4chan, A Declaration of the Independence of Cyberspace, augmented reality, barriers to entry, Benjamin Mako Hill, butterfly effect, citizen journalism, Claude Shannon: information theory, conceptual framework, corporate governance, crowdsourcing, Deng Xiaoping, discovery of penicillin, Douglas Engelbart, Douglas Engelbart, drone strike, Edward Glaeser, Edward Thorp, en.wikipedia.org, experimental subject, Filter Bubble, Freestyle chess, Galaxy Zoo, Google Earth, Google Glasses, Gunnar Myrdal, Henri Poincaré, hindsight bias, hive mind, Howard Rheingold, information retrieval, iterative process, jimmy wales, Kevin Kelly, Khan Academy, knowledge worker, lifelogging, Mark Zuckerberg, Marshall McLuhan, Menlo Park, Netflix Prize, Nicholas Carr, patent troll, pattern recognition, pre–internet, Richard Feynman, Richard Feynman, Ronald Coase, Ronald Reagan, Rubik’s Cube, sentiment analysis, Silicon Valley, Skype, Snapchat, Socratic dialogue, spaced repetition, telepresence, telepresence robot, The Nature of the Firm, the scientific method, The Wisdom of Crowds, theory of mind, transaction costs, Vannevar Bush, Watson beat the top human players on Jeopardy!, WikiLeaks, X Prize, éminence grise
Perlow describes similarly positive effects in Sleeping with Your Smartphone (Boston: Harvard Business Press, 2012), in documenting how a group of consultants with the Boston Consulting Group agreed to stay off their devices for a set number of hours per day, which they called predictable time off, and which in saner times was referred to as evenings and weekends. “an overarching ability to watch and understand your own mind”: Maggie Jackson and Bill McKibben, Distracted: The Erosion of Attention and the Coming Dark Age (Amherst, NY: Prometheus Books, 2008), Kindle edition. The first wearable was cocreated in 1960 by Claude Shannon: Edward O. Thorp, “The Invention of the First Wearable Computer,” Proceedings of the 2nd IEEE International Symposium on Wearable Computers (1998): 4–8, accessed March 23, 2013, graphics.cs.columbia.edu/courses/mobwear/resources/thorp-iswc98.pdf. Critics have already noted how unsettling it might feel: Mark Hurst, “The Google Glass Feature No One Is Talking About,” Creative Good (blog), February 28, 2013, accessed March 24, 2013, creativegood.com/blog/the-google-glass-feature-no-one-is-talking-about/; Adrian Chen, “If You Wear Google’s New Glasses You Are an Asshole,” Gawker, March 3, 2013, accessed March 24, 2013, http://gawker.com/5990395.
accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Meriwether, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative ﬁnance, random walk, regulatory arbitrage, Right to Buy, risk-adjusted returns, risk/return, Satyajit Das, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond
The companies filed for bankruptcy where such laws existed. The convertible investors didn’t get their money back; instead, they got back shares in the defaulted company. So the convertible did convert after all, there just wasn’t any blue sky – it was the dark abyss below. So, who was fooling whom? Strippers You can strip down cars. It’s the same with convertibles. Convertible stripping dates back to the 1960s. A famous 1967 book by Edward Thorp and Sheen Kassouf, Beat the Market, set out the principles of convertible arbitrage. Thorp was already well known for another book, Beat the Dealer, which set out the process of card counting in blackjack. Thorp and Kassouf outlined the idea of breaking up a convertible bond into its bond and equity parts and hedging and trading them separately. Astute traders began buying convertible bonds and stripping them.
No One Would Listen: A True Financial Thriller by Harry Markopolos
backtesting, barriers to entry, Bernie Madoff, call centre, centralized clearinghouse, correlation coefficient, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, family office, financial thriller, fixed income, forensic accounting, high net worth, index card, Long Term Capital Management, Louis Bachelier, offshore financial centre, Ponzi scheme, price mechanism, quantitative trading / quantitative ﬁnance, regulatory arbitrage, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, statistical arbitrage, too big to fail, transaction costs, your tax dollars at work
This was in early 2001, when we estimated he was running less than $20 billion. When he surrendered in 2008, it was estimated he was running roughly $65 billion. You do the sad math. About three years later Neil confirmed this to be a viable scenario. By that time he was working at Benchmark Plus in Tacoma, Washington. His employer was friendly with an extraordinarily successful investor named Edward Thorp, who had conducted due diligence on behalf of another institution many years earlier. As he told Neil’s boss, he’d gotten ahold of some of Madoff’s trade tickets and compared them to OPRA tapes. He was nice about it, but said he found some discrepancies— meaning he was unable to match all the reported trades against the OPRA data. Thorp promptly advised his clients and anyone in his network to stay away from Madoff, but didn’t take it any further.
A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber
affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, intangible asset, Jeff Bezos, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative ﬁnance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, William Langewiesche, yield curve, zero-coupon bond, zero-sum game
It was clear to Bamberger that he would last about as long as it took Tartaglia to understand the computer code behind the trading system. They had one conversation and that was it. While many who were at Morgan Stanley at the time can retell the story of Bamberger’s discovery of stat arb, its epilogue remains a blank page. Bamberger headed off to Princeton Newport, where he continued to pursue the strategy with the legendary Ed Thorp for a year, made a small fortune, and then disappeared from the world of trading. This move was a natural. Thorp was the first great analytically oriented trader. An MIT mathematician, he was the author of Beat the Dealer (Random House, 1966), which introduced the concept of card counting to blackjack. He wrote the book to spread his techniques after he had been banned by most casinos and could no longer pursue the strategy for profit.
New Market Wizards: Conversations With America's Top Traders by Jack D. Schwager
backtesting, beat the dealer, Benoit Mandelbrot, Berlin Wall, Black-Scholes formula, butterfly effect, commodity trading advisor, computerized trading, Edward Thorp, Elliott wave, fixed income, full employment, implied volatility, interest rate swap, Louis Bachelier, margin call, market clearing, market fundamentalism, money market fund, paper trading, pattern recognition, placebo effect, prediction markets, Ralph Nelson Elliott, random walk, risk tolerance, risk/return, Saturday Night Live, Sharpe ratio, the map is not the territory, transaction costs, War on Poverty
After your job was eliminated, did you get another position as an analyst? No, I got a job selling time on large computers. However, that position was essentially a marketing slot, and I was interested in doing analytical work. After about a year, I left to take a job in operations research for Kaiser Cement. At that time, I got interested in playing blackjack by reading a book called Beat the Dealer by Ed Thorp. From 1971 to 1975, I went to the Nevada casinos regularly. Did you live in Nevada at the time? No, I lived in California. But I would take a blackjack trip every chance I got. I probably spent about five days a month in Nevada during that time. In a sense, I owe everything that I have to the state of Nevada. It not only provided me with my original trading stake, but the betting experience taught me a lot of things that allowed me to become a successful trader.
Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager
Asian financial crisis, banking crisis, barriers to entry, beat the dealer, Black-Scholes formula, commodity trading advisor, computer vision, East Village, Edward Thorp, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John Meriwether, John von Neumann, locking in a profit, Long Term Capital Management, margin call, money market fund, Myron Scholes, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K
For various reasons, the vast majority of the high-quality work that appears in the open literature can't be used in practice to actually beat the market. Conversely, the vast majority of the research that really does work will probably never be published. But there are a few successful quantitative traders who from time to time publish useful information, even when it may not be in their own selfinterest to do so. My favorite example is Ed Thorpe, who was a real pioneer in the field. He was doing this stuff well before almost anyone else. Ed has been remarkably open about some of the money-making strategies he's discovered over the years, both within and outside of the field of finance. After he figured out how to beat the casinos at blackjack, he published Beat the Dealer. Then when he figured out how to beat the market, he published Beat the Market, which explained with his usual professorial clarity exactly how to take advantage of certain demonstrable market inefficiencies that existed at the time.
Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das
affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative ﬁnance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game
The insurer’s profit was the difference between statistical loss experience, based on historical knowledge of claims, and the premiums paid, plus investment income on the premiums. Applying insurance theory to options proved difficult. Louis Bachelier applied random walk models to pricing options. Paul Cootner and Paul Samuleson worked on the problem. In their 1967 book Beat the Market, mathematicians Sheen Kassouf and Edward Thorp outlined the relationship between the price of an option and the price of the underlying stock. Thorp, whose interest was gambling and beating the casino at roulette and baccarat, developed a model, anticipating the Black-Scholes equation. With a background in physics and mathematics, Fischer Black worked at Arthur D. Little, a financial consulting firm. While at the University of Chicago, Black collaborated with Myron Scholes, whose Ph.D. focused on using arbitrage to ensure that securities with similar risks offered similar returns.
Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle by Diana B. Henriques
accounting loophole / creative accounting, airport security, Albert Einstein, banking crisis, Bernie Madoff, break the buck, British Empire, centralized clearinghouse, collapse of Lehman Brothers, computerized trading, corporate raider, diversified portfolio, Donald Trump, dumpster diving, Edward Thorp, financial deregulation, financial thriller, fixed income, forensic accounting, Gordon Gekko, index fund, locking in a profit, mail merge, merger arbitrage, money market fund, Plutocrats, plutocrats, Ponzi scheme, Potemkin village, random walk, Renaissance Technologies, riskless arbitrage, Ronald Reagan, short selling, Small Order Execution System, source of truth, sovereign wealth fund, too big to fail, transaction costs, traveling salesman
They always had the best systems.” 92 whose accounts now totalled at least $8 billion: Letter from BLM, Oct. 3, 2010. Madoff estimated that client account balances totaled $5 billion in 1987; if so, the annual investment returns he claimed to be producing would have pushed that number, conservatively, to about $8 billion by the early 1990s. 93 the harder it would be for savvy investors to believe: Indeed, as early as 1991, the pioneering quantitative analyst Edward Thorp looked at the results Madoff was producing for a pension fund client and found some red flags, including a day in April 1991 when Madoff’s reported trades in Procter & Gamble options were more than ten times the total number of P&G options traded that day. See Scott Patterson, The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It (New York: Crown Business, 2010), p. 63. 94 a pair of sceptical investors had sent two documents: Kotz Report, pp. 42–44, and Kotz Report, Exhibit 113, p. 1. 94 The fact sheet was on the letterhead of a financial adviser in San Francisco: Ibid., p. 43. 95 “relatives, friends and former clients”: Ibid. 95 he had received a call from his friend Richard Glantz: Avellino-Bienes SEC Transcript, pp. 12–14. 95 one of the earliest subcontractors: The elder Glantz was a partner with accountant Steven Mendelow in the Telfran fund, an indirect Madoff feeder fund that invested through Avellino & Bienes.