History, Shocks and Drifts: A New Approach to Portfolio Formation
25 Pages Posted: 12 Mar 2021 Last revised: 7 May 2021
Date Written: March 10, 2021
Investors intuitively view future possibilities as a combination of historical outcomes, shocks that occur suddenly, and drifts that unfold gradually over several years. The authors show how to build portfolios based on such a view of the future. Their key innovation is to create a mixed-frequency return sample that properly balances short-term and long-term returns, and to form portfolios by considering all the returns of the sample instead of a statistical summary of them.
Keywords: Certainty equivalent, Drift, Expected utility, Full-scale optimization, Kinked utility function, Kurtosis, Log-wealth utility, Mean-variance analysis, Mixed-frequency return sample, Skewness, Shock, Sum of utilities Utility of sums
JEL Classification: C1, C10, C11, C13, C15, C18, G1, G11, G17
Suggested Citation: Suggested Citation