Alpha
Alpha measures performance relative to an expected or benchmark return after applying a specified risk adjustment. In the simple CAPM form of Jensen's alpha, alpha equals the realised investment return minus [risk-free rate + beta × (market return − risk-free rate)] for the same period and consistent inputs. Positive alpha indicates outperformance against that model, not proof of skill or a guarantee of future gains. Results depend on the benchmark, assumptions, fees and measurement period; other alpha definitions and models exist.
Worked example
A portfolio returns 12%, the risk-free return is 2%, the market return is 8% and beta is 1.0. The CAPM benchmark is 2% + 1 × (8% − 2%) = 8%, so simple realised alpha is 12% − 8% = 4 percentage points before any omitted fees or model adjustments.
Common mistake
Subtracting only beta times the market return without including the risk-free component, or treating a positive historical alpha as guaranteed future outperformance.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Supporting | September 2026–June 2027 |