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by behrlich 1842 days ago
Another word of caution. The Kelly Criterion depends on each event being independent. Lets say I'm told to allocate 50% to QQQ and 50% to SPY. Those may independently be correct, but since the NASDAQ and S&P are highly correlated, this wouldn't be the correct allocation. You've essentially allocated 100% of your portfolio to one probability, rather than 50% to two independent probabilities.

This is an obvious example. But really all stocks (or at least sectors) are correlated just like this. So other examples wouldn't be so obvious.
2 comments
kqr 1841 days ago
> The Kelly Criterion depends on each event being independent.

That's not quite true. The Kelly criterion (generalised to portfolio selection) requires the joint distribution of outcomes, which captures all correlations.

Taking somewhat recent historic outcomes as representative of the joint distribution of outcomes (this effectively becomes the Cover universal portfolio), I'm guessing the Kelly criterion would suggest something like 50 % cash and 50 % equity, if those are the only two options.

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epapsiou 1842 days ago
True. Correlations are not modeled in here. And the fact is once shit hits the fan all correlation converge to 1. This is not a tool for helping you with that. All it does is tells you - don't put more than x% in this stock. It answers a very specific question --- I like XYZ, how much should I buy?
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LudwigNagasena 1841 days ago
There are many assets and securities that are inversely correlated with the stock market like gold or inverse ETFs.
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