Overview
Alpha measures how well an investment performs relative to an appropriate market index. When alpha = 1, it means that the return on investment during a specfic time period outperforms the overall market average by 1%. When alpha = -1, it indicates that the investment underperforms the market average. To calculate the alpha, we can use the capital assets pricing model (CAPM) formula which is shown as follows:
r = Rf + Beta (Rm - Rf) + Alpha
Where:
r = return on the portfolio
Rf = risk-free return
Beta = market risk (systematic risk) of the portfolio
Rm = market return
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