Optimal asset allocation with mutual information

This paper discusses an optimal equity growth trading strategy based on mutual information in communication theory and examines its application for asset allocation in financial investment. Specifically, The asset allocation formula derived from channel capacity of a binary symmetric channel (Kelly's formula) is used to determine the optimal fraction of equity to be invested in a repeated trading activity utilizing derivatives such as S&P futures and options. An analytical operating curve to predict trading performance is also provided. The simulated trading performance results demonstrate the effectiveness of the methodology.