New: Book Report: Fortune's Formula

William Poundstone wrote Prisoner's Dilemma, one of my favorite books ever. That book convinced me to look more closely at the prisoner's dilemma, and that in turn changed the way that I think about life.

Fortune's Formula, his latest book, touches on many interesting topics. It's about the Kelly formula. What's the Kelly formula? Suppose you know of a gambling game that pays 100:1. But you think that the game designer made a mistake: you have a 1/50 chance of winning this game. You can play this game once a day. How much of your money should you throw at it? Well, the game is in your favor, so you want to throw a lot of money at it. But you don't want to put in all of your money at once: you would have a 49/50 chance of going bust. You could play $1 per day, and know that you'd make some money in the long run with little risk--but surely if you risked more, you could gain more. The Kelly formula looks at a game's risk and payoff; it tells you what percentage of your stake to gamble on that game.

That doesn't sound so interesting on its own. BUT Poundstone tied this formula into the history of information theory and the economics of markets. He writes about Claude Shannon and his attempts to win at Roulette by tracking ball movements and using an early computer. He writes about Ed Thorp, the guy who wrote Beat the Dealer and later moved away from blackjack and over to hedge funds. He writes about organized crime trying to go legit. He writes about Milken and the investment scandals of the 80s... uhm, maybe he includes too much material about that. There's an academic economics paper (mostly) in words of one syllable.

Ah, this book is so full of great stuff, I just have to share some personal favorites.

Possibly [mobster] Zwillman's most peculiar investment was another wire service [besides the one he used to transmit advance notice of horse race results]. It was a company that ran wires to wealthy subscribers' homes. The wirse carried opera and other soothing music. The firm prospered only when it offered its service for stores, offices, and elevators. In 1954 the Chicago Crime Commission concluded that the Muzak Corporation was controlled by the notorious Longy Zwillman. Zwillman said he was merely a stockholder.

I guess I shouldn't be so mad at stores that keep playing Christmas music all the time; if they stop, I guess the manager gets shot in the kneecaps.

Shannon's "Ultimate Machine" was the size and shape of a cigar box. On the front panel was a toggle switch. The unsuspecting visitor was invited to flip the switch on. When that happened, the top slowly opened. A robot hand emerged, reached down, and flipped the switch off. The hand retreated, the lid snapped shut.

Also on the subject of mobsters and music, this book talks about how mob money took over Warner Brothers.

There is a neat comparison between Maxwell's Demon, which converts information into energy; and the attempts of investors to turn information into money.

All the same, I hope that this book doesn't change my life as much as The Prisoner's Dilemma. People think I'm dull enough as a computer programmer; if I start playing poker professionally, I think they'll give up on me.

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Posted 2006-01-21