Definition
Jensen's alpha measures the value added (or subtracted) by a portfolio manager relative to a passive benchmark strategy with the same beta risk. Positive alpha indicates the manager generated returns above what could be achieved by simply taking on market risk. Negative alpha means the manager underperformed a passive strategy of equivalent risk.
functions Formula
α = Rp − [Rf + β × (Rm − Rf)]
lightbulb Example
Portfolio returns 14%, risk-free 4%, market return 10%, portfolio beta 1.2. Expected return = 4% + 1.2×(10%-4%) = 11.2%. Alpha = 14% - 11.2% = 2.8%. The manager added 2.8% above what the market risk explains.
verified_user Key Points
- Measures manager skill above market-risk compensation
- Positive alpha = genuine outperformance
- Based on CAPM expected return
- Persistence of alpha is debated in academic finance