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Ed Thorp, a math professor at Massachusetts Institute of Technology, had an insight into the card game blackjack that would forever changes the casino industry: Players could beat the house by using a simple formula for tracking cards, he explained on this week’s Masters in Business podcast. Thorp, a legend in gambling circles and author of “Beat the Dealer,” and “Beat the Market,” has just published his autobiography, “A Man for All Markets.”
Thorp made so much money in Las Vegas that he was kicked off the blackjack tables in many casinos. But the casinos industry didn’t believe baccarat could be beaten, so he was allowed to play that — until his winnings started piling up. Eventually, he and Claude Shannon, a fellow professor of information theory at MIT, developed a way to beat roulette, the game with some of the longest odds, involving a wearable computer. That also worked, leading him to get banned from casinos everywhere.
With Vegas off limits, he began thinking about ways to use his expertise in probability analysis and mathematics, where risk and reward was broadly misunderstood. This naturally led Thorp to the stock market. He quickly discovered mispricing in related securities. Thus he effectively created the field of statistical arbitrage. He applied his theories via one of the first quant hedge funds, earning returns of as much as 25 percent a year for more than a decade.
Thorp was an early investor in Berkshire Hathaway Inc. and still owns the shares. During our conversation (and in his new autobiography), he recalls extrapolating Buffett’s annual returns and being unable to find any reason why size or scale would limit Berkshire’s growth. He told his wife that “one day, Warren Buffett will be the wealthiest man in America, if not the world.” Thorp was also an early investor in Kenneth Griffin’s Citadel LLC, and he continues to be a passive shareholder. And he warned a few people that Bernie Madoff was a fraud many years in advance.
All of the books Thorp cited can be found here.
You can stream/download the full conversation, including the podcast extras, on iTunes, Soundcloud, Overcast and Bloomberg. Our earlier podcasts can all be found on iTunes, Soundcloud, Overcast and Bloomberg.
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