History, Shocks, and Drifts: A New Approach to Portfolio Formation

Abstract

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.