Mutual Information for Optimal Asset Allocation.

Dynamic asset allocation in financial investment with an optimal equity growth principle based on mutual information in communication theory is considered. Specifically, the asset allocation formula using Kelly's criteria derived from channel capacity of a binary symmetric channel is developed. The goal is to determine the optimal fraction of equity to be invested between a risk-free asset and a risky asset in a repeated trading activity. The analytical operating curve to predict trading performance is provided. An extension for dynamic multi-asset allocation is also presented. An out-of-sample simulation based on historical market data demonstrates the effectiveness of the methodology. [ABSTRACT FROM AUTHOR]