![]() ![]() The best examples for the US are the S&P 500 and the Wilshire 5000 which approximately represent the 500 most widely held equities and the largest 5000 securities respectively, accounting for approximately 80%+ and 99%+ of the total market capitalization of the US market as a whole. In this context, because returns are being compared with the theoretical return of CAPM and not to a market index, it would be more accurate to use the term of Jensen's alpha.Ī belief in efficient markets spawned the creation of market capitalization weighted index funds that seek to replicate the performance of investing in an entire market in the weights that each of the equity securities comprises in the overall market. ![]() The alpha coefficient ( α i : the investment has a return in excess of the reward for the assumed riskįor instance, although a return of 20% may appear good, the investment can still have a negative alpha if it's involved in an excessively risky position. This is useful for non-traditional or highly focused funds, where a single stock index might not be representative of the investment's holdings.ĭefinition in capital asset pricing model Returns on that portfolio can be compared with the theoretical returns, in which case the measure is known as Jensen's alpha. It is also possible to analyze a portfolio of investments and calculate a theoretical performance, most commonly using the capital asset pricing model (CAPM). Historically, the vast majority of traditional funds have had negative alphas, which has led to a flight of capital to index funds and non-traditional hedge funds. As these funds include various fees normally expressed in percent terms, the fund has to maintain an alpha greater than its fees in order to provide positive gains compared with an index fund. In modern financial markets, where index funds are widely available for purchase, alpha is commonly used to judge the performance of mutual funds and similar investments. Alpha, along with beta, is one of two key coefficients in the capital asset pricing model used in modern portfolio theory and is closely related to other important quantities such as standard deviation, R-squared and the Sharpe ratio. An alpha of 1% means the investment's return on investment over a selected period of time was 1% better than the market during that same period a negative alpha means the investment underperformed the market. ![]() JSTOR ( March 2016) ( Learn how and when to remove this template message)Īlpha is a measure of the active return on an investment, the performance of that investment compared with a suitable market index.Unsourced material may be challenged and removed. Please help improve this article by adding citations to reliable sources. This article needs additional citations for verification. ![]()
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