Jensen's alpha
INVESTOPEDIA | 2014-06-05 17:17
In finance, Jensen's alpha (or Jensen's Performance Index, ex-post alpha) is used to determine the abnormal return of a security or portfolio of securities over the theoretical expected return.
The security could be any asset, such as stocks, bonds, or derivatives. The theoretical return is predicted by a market model, most commonly the capital asset pricing model (CAPM). The market model uses statistical methods to predict the appropriate risk-adjusted return of an asset. The CAPM for instance uses beta as a multiplier.
Calculation
In the context of CAPM, calculating alpha requires the following inputs:
• the realized return (on the portfolio),
• the market return,
• the risk-free rate of return, and
• the beta of the portfolio.
Jensen's alpha = Portfolio Return − [Risk Free Rate + Portfolio Beta * (Market Return − Risk Free Rate)]
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