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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