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Journal of Bioeconomics

, Volume 20, Issue 1, pp 49–67 | Cite as

The growth of relative wealth and the Kelly criterion

  • Andrew W. Lo
  • H. Allen Orr
  • Ruixun Zhang
Article

Abstract

We propose an evolutionary framework for optimal portfolio growth theory in which investors subject to environmental pressures allocate their wealth between two assets. By considering both absolute wealth and relative wealth between investors, we show that different investor behaviors survive in different environments. When investors maximize their relative wealth, the Kelly criterion is optimal only under certain conditions, which are identified. The initial relative wealth plays a critical role in determining the deviation of optimal behavior from the Kelly criterion regardless of whether the investor is myopic across a single time period or maximizing wealth over an infinite horizon. We relate these results to population genetics, and discuss testable consequences of these findings using experimental evolution.

Keywords

Kelly criterion Portfolio optimization Adaptive Markets Hypothesis Evolutionary game theory 

JEL Classification

G11 G12 D03 D11 

Notes

Acknowledgements

Research support from the MIT Laboratory for Financial Engineering and the University of Rochester is greatly acknowledged.

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Copyright information

© Springer Science+Business Media, LLC 2017

Authors and Affiliations

  1. 1.Sloan School of ManagementMassachusetts Institute of TechnologyCambridgeUSA
  2. 2.Laboratory for Financial EngineeringMassachusetts Institute of TechnologyCambridgeUSA
  3. 3.Computer Science and Artificial Intelligence LaboratoryMassachusetts Institute of TechnologyCambridgeUSA
  4. 4.Department of BiologyUniversity of RochesterRochesterUSA

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