Growth versus Security Tradeoffs in Dynamic Investment Analysis
by
Leonard C. MacLean
Dalhousie University, Halifax, Nova Scotia
Coauthors: William T. Ziemba (University of British Columbia, Vancouver)

This paper presents an approach to the problem of optimal dynamic choice in discrete or continuous time where there is a direct tradeoff of growth versus security. In each period the investor must allocate the available resources among various risky assets. The maximization of the expected logarithm of the period by period wealth, called the capital growth or Kelly criterion has many desirable properties such as maximizing the asymptotic rate of asset growth. However, this strategy has low risk aversion and typically has very large wagers which yield high variance of wealth. With uncertain parameters this can lead to overbetting and loss of wealth. Using fractional Kelly strategies leads to a less volatile and safer sequence of wealth levels with less growth. The investor can choose a desirable tradeoff of growth and security appropriate for the problem under consideration. This approach yields simple two dimensional graphs analogous to static mean variance analysis, that capture the essence of the dynamic problem in a form useful for sound investment analysis. Use of the approach in practice is illustrated on favorable investments in blackjack, horseracing, lotto games, index and commodity futures and options trading.

Date received: February 11, 1999

Copyright © 1999 by the author(s). The author(s) of this document and the organizers of the conference have granted their consent to include this abstract in Atlas Conferences Inc. Document # cacq-06.