Performance & risk

Alpha

Return beyond the amount predicted by a selected risk model.

01 / Definition

What Alpha Means

Alpha is realized return minus the return expected from a model such as CAPM. It depends on the benchmark, beta, risk-free rate, period, and chosen model.

02 / Calculation

Alpha Formula

Jensen's α = Rₚ − [R𝒻 + βₚ(Rₘ − R𝒻)]

03 / Worked Example

How to Read the Result

With 11% portfolio return, 3% risk-free return, 8% market return, and beta of 1.2, expected return is 9% and alpha is 2 percentage points.

04 / Boundaries

Limitations

Alpha changes with the model and benchmark.
Short histories create unstable estimates.
Unmodeled factors can be mistaken for skill.

05 / Questions

Common Questions

Can positive return have negative alpha?

Yes. Realized return can be positive but still below the model's expected return.