Book review – Fortune’s Formula

11Nov05

Members of the finance and investment community are often loath to acknowledge any connection between investing and gambling. William Poundstone, a Pulitzer Prize nominee, has written an interesting book, Fortune’s Formula, that goes beyond the mathematics and brings to life the sometimes seamy underbelly of business and investment management.

Poundstone attempts to marry the two by examining the theory and history of something called, the Kelly criterion. This formula prescribes how much a gambler (or investor) should wager on a given outcome so as to maximize the compound growth of one’s bankroll. The Kelly criterion is well known in the world of gambling, but according to Poundstone is seriously unacknowledged in the world of academic finance and investment management.

The book is in large part the story of Ed Thorpe and his rise in the worlds of academic mathematics, gambling and investment management. Thorpe has written himself about these topics, but this book puts his work into a larger context. Although less well known the genius of Claude Shannon, and John Kelly himself, also play an important role in the manuscript.

Most investment books are poorly conceived and poorly written. Investors are better off trying to better educate themselves about the broader world of science, mathematics and finance than to read about the latest and greatest, foolproof investment strategy. Fortune’s Formula, while flawed, is a good addition to an investor’s reading list.

Other reviews on the web:

Elwyn Berlekamp in American Scientist pens a learned review that is generally favorable, but acknowledges issues with the book.

In my experience, abstract financial mathematics is the only truly significant commonality between the world of finance and the world of racetracks and casinos. Poundstone has been lured by Kelly’s colorful terminology into seriously overemphasizing the relevance and importance of whatever other relationships might exist. Portrayal of the seamy side of business is a genre that runs at least as far back as the novels of Charles Dickens. Readers who are looking for something in that vein as well as a light introduction to financial mathematics will find things to relish in Poundstone’s book.

BusinessWeek gives the book 4 out of 5 stars.

Fortune’s Formula will appeal to readers of such books as Peter L. Bernstein’s Against the Gods, Nassim Nicholas Taleb’s Fooled by Randomness, and Roger Lowenstein’s When Genius Failed. All try to explain why smart people take stupid risks. Poundstone goes them one better by showing how hedge fund Long-Term Capital Management, for one, could have avoided disaster by following the Kelly metho

James Pressley in Bloomberg.com with another favorable review.

The book meshes science with storytelling, evoking a cast of characters that stretches from J. Edgar Hoover and shady bookies to Nobel laureate economist Paul Samuelson, with cameo appearances by the likes of actor Paul Newman and composer John Cage. The potboiler treatment is highly readable, though at times distracting, as the book actually revolves around three brainy guys and a slew of equations.