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
Portfolio may refer to:
Objects
* Portfolio (briefcase), a type of briefcase
Collections
* Portfolio (finance), a collection of assets held by an institution or a private individual
* Artist's portfolio, a sample of an artist's work or a c ...
of securities over the theoretical expected return. It is a version of the
standard alpha based on a theoretical performance instead of a
market index
Market is a term used to describe concepts such as:
* Market (economics), system in which parties engage in transactions according to supply and demand
* Market economy
*Marketplace, a physical marketplace or public market
Geography
*Märket, a ...
.
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.
History
Jensen's alpha was first used as a measure in the evaluation of
mutual fund
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
managers by
Michael Jensen in 1968. The CAPM return is supposed to be 'risk adjusted', which means it takes account of the relative riskiness of the asset.
This is based on the concept that riskier assets should have higher expected returns than less risky assets. If an asset's return is even higher than the risk adjusted return, that asset is said to have "positive alpha" or "abnormal returns". Investors are constantly seeking investments that have higher alpha.
Since
Eugene Fama
Eugene Francis "Gene" Fama (; born February 14, 1939) is an American economist, best known for his empirical work on portfolio theory, asset pricing, and the efficient-market hypothesis.
He is currently Robert R. McCormick Distinguished Servic ...
, many academics believe financial markets are too
efficient to allow for repeatedly earning positive Alpha, unless by chance. Nevertheless, Alpha is still widely used to evaluate mutual fund and portfolio manager performance, often in conjunction with the
Sharpe ratio
In finance, the Sharpe ratio (also known as the Sharpe index, the Sharpe measure, and the reward-to-variability ratio) measures the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for its ...
and the
Treynor ratio The Treynor reward to volatility model (sometimes called the reward-to-volatility ratio or Treynor measure), named after Jack L. Treynor, is a measurement of the returns earned in excess of that which could have been earned on an investment that has ...
.
Calculation
: