Jensen’s Alpha is a performance metric used to evaluate the excess return of an investment portfolio compared to the expected return predicted by the Capital Asset Pricing Model (CAPM). It is calculated using the formula:
where:
A positive Jensen’s Alpha indicates that the portfolio has outperformed its expected return, suggesting that the manager has added value beyond what would be expected based on the portfolio's risk. Conversely, a negative alpha implies underperformance. Thus, Jensen’s Alpha is a crucial tool for investors seeking to assess the skill of portfolio managers and the effectiveness of investment strategies.
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