Jensen's Alpha, also known as the Jensen index or the
Jensen's Performance Index, is a metric used in finance to evaluate the
performance of a particular investment portfolio relative to its expected
returns based on the level of risk taken by the investor. It is named after
Michael Jensen, a Nobel laureate in economics who developed the concept.
Jensen's Alpha is a risk-adjusted measure of the excess
return of an investment over its expected return, given its level of systematic
risk (beta). It is calculated as the difference between the actual return on an
investment and the return that would be expected given the level of risk of the
investment, as determined by its beta, multiplied by the market risk premium.
In other words, Jensen's Alpha measures how much an investment outperforms or underperforms its expected returns based on the amount of risk taken by the investor. A positive Jensen's Alpha indicates that the investment has outperformed its expected returns, while a negative Jensen's Alpha indicates underperformance.
Jensen's Alpha is a metric that measures the excess returns
of an investment portfolio over its expected returns based on the portfolio's
level of risk. It is also known as the "Jensen Index" or
"Jensen's Performance Index."
Jensen's Alpha is calculated by subtracting the expected
return on a portfolio, as estimated by the Capital Asset Pricing Model (CAPM),
from the actual return of the portfolio. The difference is then divided by the
portfolio's beta, which measures the portfolio's volatility relative to the
market. The formula for Jensen's Alpha is:
Jensen's Alpha = Portfolio Return - [Risk-Free Rate + Beta x
(Market Return - Risk-Free Rate)]
Jensen's Alpha is useful for investors because it provides a measure of whether a portfolio has outperformed or underperformed its expected returns, taking into account the level of risk the portfolio is exposed to. This metric is helpful in evaluating the performance of investment managers or individual portfolios, as well as in constructing diversified portfolios that balance risk and return. Investors can use Jensen's Alpha to determine whether a portfolio has generated value in excess of its cost of capital, which is a key factor in evaluating investment performance.
Jensen Alpha helps investors to evaluate the performance of their investments and determine whether their investment decisions have added value over and above the market. A positive Jensen Alpha indicates that the investment has outperformed the market, while a negative Jensen Alpha suggests that the investment has underperformed the market.
Overall, Jensen Alpha is a useful tool for investors to determine the efficiency of their investment strategies and make informed investment decisions based on risk-adjusted returns.
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