The Physics of Wall Street: a brief History of Predicting the Unpredictable

Beating the Dealer 
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the dean of Uc Irvine’s graduate school—in a sense, thorp’s boss—
had inherited a fortune. He was looking to invest with a new fund, be-
cause his old money manager was moving on to other projects. thorp 
was close to home, but before Gerard would invest with the new part-
nership, he wanted his old money manager, a trusted friend, to take a 
careful look at thorp. thorp agreed to the meeting, and one evening 
he and vivian drove a few miles down the Pacific coast Highway, to 
Laguna Beach, where the old money manager lived. the plan was to 
play bridge and chat casually, so that the old money manager could 
size thorp up.
thorp learned that his host was leaving the money management 
business to focus on a new venture — an old manufacturing and tex-
tiles company that he was hoping to rebuild. He’d made his first mil-
lion managing other people’s money, and now it was time to put his 
own money to work. But mostly, thorp and his host discussed prob-
ability theory. While they were playing, the host mentioned a kind 
of trick dice, called nontransitive dice. nontransitive dice are a set of 
three dice with different numbers on each side. they have the unusual 
property that if you roll dice 1 and 2 at the same time, die 2 is favored; 
if you roll dice 2 and 3 at the same time, die 3 is favored; but if you 
roll dice 1 and 3 at the same time, die 1 is favored. thorp, always a fan 
of games and the probabilities associated with them, had long been 
interested in nontransitive dice. from that point on, the two were fast 
friends. on the ride back to newport Beach, thorp told vivian that 
he expected their host to someday be the richest man in the world. In 
2008, his prediction came true. the old money manager’s name was 
Warren Buffett. And at his recommendation, Gerard invested with 
thorp’s company.
Princeton-newport Partners quickly became one of the most suc-
cessful hedge funds on Wall Street. But all good things must end. And 
Princeton-newport’s demise was particularly dramatic. on decem-
ber 17, 1987, about fifty fBI, Atf, and treasury department agents 
pulled up in front of the firm’s Princeton office. the agents stormed 
into the building, looking for records and audiotapes regarding a se-
ries of trades the firm had made with the soon-to-be-indicted junk 
bond dealer Michael Milken. A former Princeton-newport employee 

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named William Hale had testified to a grand jury that regan and 
Milken were engaged in a tax dodge known as stock parking. one 
downside to delta hedging and related strategies is that profits from 
short-term and long-term positions are taxed differently. So when you 
buy and sell at the same time, profits and losses that otherwise would 
cancel each other out don’t cancel from a tax perspective. regan was 
trying to avoid additional taxes by concealing who actually owned 
the long-term positions, “parking” the stocks at Milken’s firm. Parked 
stocks were officially sold to Milken, with an unofficial agreement that 
regan could buy them back for a predetermined price, irrespective of 
what had happened in the market in the meantime. though hardly 
nefarious, stock parking was illegal, and rudy Giuliani, who was pros-
ecuting the case, hoped that by applying pressure on the Princeton-
newport side, he could dig up additional evidence against Milken.
By all accounts, thorp was completely in the dark. He didn’t know 
that the east coast side of the firm was doing anything illegal until the 
scandal broke in the news. He was never accused of, let alone charged 
with, any crime. And by the time he got wind of the raid, regan al-
ready had a lawyer and refused to talk to his partner. the firm hobbled 
along for another year, but the legal proceedings had ruined its reputa-
tion. In 1989, Princeton-newport Partners closed. over the course of 
twenty years, it had average returns of 19% (over 15% after fees) — an 
unprecedented performance.
After Princeton-newport closed, thorp took some time off be-
fore regrouping to form edward o. thorp Associates, his own money 
management firm. though he has long since given up managing other 
people’s money professionally, he still runs the fund today using his 
own capital. Meanwhile, hundreds of quant hedge funds have opened 
(and closed), trying to reproduce Princeton-newport’s success. As the