MiB Ed Thorp on Beating Vegas & Wall Street

This week (for our 3rd anniversary broadcast) we sit down with Ed Thorp, the MIT and UC Irvine math professor professor who Beat the Dealer, and Beat the Market, and became the first true quant hedge fund manager. His new autobiography is A Man for All Markets.

At the time he was a mathematics professor at MIT, Thorp realized that the house edge in Black Jack could be shifted in a player’s direction with a simple formula for tracking the cards that had been already seen. This was the first simple form of card-counting that was accessible to any player. He eventually made enough money in Vegas that he was kicked out of the Black Jack tables in many casinos.

However, Casinos didn’t believe Baccarat could be beaten, so they did let him play that — until Thorp started taking them for more money there. They kicked him off of those tables as well. In response, he wrote Beat the Dealer, leading to many changes in how all casinos manage their risk as the House when dealing either of those games. Eventually, he and Claude Shannon, a fellow professor of information theory at MIT, created a wearable computer to beat roulette (!). That also worked, leading him to get banned from casinos everywhere.

With Vegas eventually unavailable to him, 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 mispricings in related securities – at first the combination of equities and warrants, eventually the equity/option mix. Thus, he effectively created the field of statistical arbitrage, expressing this in a hedge fund that returned 20-25% per year for more than a decade. The minimums in the firm quickly rose from $50,000 to 10 million dollars.

Thorp was an early investor in Berkshire Hathaway, buying BRK for $982 (he still owns the shares). During our conversation (and in his new autobiography), he recalls extrapolating Buffett’s annual returns, unable to find where size or scale would limit [Berkshire’s] growth for many decades. 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, and continues to be a passive shareholder. And he warned a few people that Bernie Madoff was a fraud many years in advance. Those are only a few examples of how Thorp’s mathematics genius was expressed in the investment world from his latest book, isA Man for All Markets.

All of the books Thorp references 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..

Next week, we speak with Pulitzer Prize winning journalist Jesse Eisinger, author of The Chickenshit Club: Why the Justice Department Fails to Prosecute Executives.