The recent book ‘Fortune’s Formula’ by William Poundstone centers on the method by which the most skilful Gamblers manage their Risk, a method demonstrably more effective than the way most professional Risk Managers manage theirs. One of the many side-stories in the book is the explanation of how research into Gambling led to the mathematical breakthrough which made digital computing not only possible but ubiquitous.
The story begins in the period just preceding the violent death of Ben ‘Bugsy’ Siegel, the notorious gangster who, in addition to putting Las Vegas on the map, also happened to own all of the horseracing ‘wire’ services in the United States in the late 1940’s, the income from which (chiefly generated by selective delays of race results) formed the lion’s share of the revenue for an otherwise unprofitable company called the American Telephone and Telegraph Company (AT&T). Following the death of Siegel, AT&T continued to grow and prosper, and opened a research facility in Morristown N.J. called Bell Laboratories. Not surprisingly, one of the earlier research efforts was an investigation into to the mathematics of how a bookmaker should behave so as to optimise his (or her) revenue in the presence of … delayed racing results. In particular, the development of a method for quantifying the financial value of a wire service of this type became a priority. A very elegant result on this problem appeared in 1952 entitled, “A New Interpretation of the Information Rate” (an apparently somewhat disguised title), by one JL Kelly, Jr. In the course of this research, Kelly and a colleague, Claude Shannon had formulated a whole new field of mathematics, called Information Theory. One outcome of this research was a relation between Information content in a notional sense, and Information units, as measured in ‘Binary Digits’ or ‘bits’. This turned out to be the missing piece of a puzzle which had remained unfinished since the untimely death of the English mathematician Alan Turing (who had used mathematics to break the Enigma code during WWII). Soon after publication of this paper, Kelly’s and Shannon’s innovation paved the way for what was to become the Digital Computer.
It was only some time later that Shannon (who later became a Professor at MIT) realised that Markets (and the people who participate in them) are not always rational, and that it is in fact possible to apply Information Theory to gain financial advantage without a wire service. At the time of his death in the late 1990’s Claude Shannon left a portfolio of assets, the returns for which had significantly outstripped those of virtually every other known investor or fund on record over the same period, significantly ahead of even Warren Buffett. Shannon had achieved this without any knowledge of Financial Markets (apart from Information Theory).
For my own part, I began a relationship with horseracing based on the desire to earn a bit more than my spartan salary as an academic in Australia. Without discovering Kelly’s and Shannon’s work until sometime later, I had come to many of the same conclusions mathematically myself, and even managed to extended Kelly’s and Shannon’s work in well-known journals. At the same time, I had also had to come to terms with the knowledge that any money I made in racing was being taken from others, possibly even from some who were less well-off than myself, some possibly with serious gambling issues, and most of whom were very likely at a significant mathematical disadvantage in relation to myself. Without entering into a moral comparison of profiting from a crooked wire service versus profiting from others’ mathematical shortcomings, I know that in some sense, when I bet successfully, I am engaging in an activity which is at least somewhat ‘non-nice’.
Having admitted this, I wonder if I can partially let myself ‘off the hook’ by acknowledging the possibility that perhaps sometimes something good can arise which would not have done without the Dark Side.