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Old 09-11-2006, 08:45 AM
Izverg04 Izverg04 is offline
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Join Date: Mar 2004
Posts: 308
Default Re: Terror in Poker and Finance Part II

By the way, here is a very simple way, based on Expected Utility theory, to appraise you risk. For small bets (small compared to bankroll), expected utility or the Certainty Equivalent of a play is:

CE=EV-Var/2R,

where EV and Var are expected value and StdDev^2 of a gamble, and R is the Kelly bankroll (equal to e.g. bankroll/4 for Kelly/4 bettors).

Actually, more formally, R is the curvature of your utility function R=-U'(x)/U''(x). I assumed here that R remains about the same whatever the result of the gamble is (thus the caveat about small bets).

No need for fancy ratios from quantitative finance. Find CE for the choices that you have and make the decision that maximizes CE. Most of the time you'll make the same choice as if you were maximizing EV, while taking occasional EV hits in marginal situations, where cost of variance is too high.
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