Question

The Jensen's alpha of a portfolio is equal to zero. Choose the following option which provides the correct interpretation for this result.
Select one:
a. The return of the portfolio is equal to the portfolio return implied by the CAPM given the exposure of the portfolio to the market portfolio.
b. The portfolio has out-performed the portfolio return implied by the CAPM given the exposure of the portfolio to the market portfolio.
c. The return of the portfolio is equal to the portfolio return implied by the Fama-French three-factor model given the exposure of the portfolio to systematic risk factors.
d. The portfolio has under-performed the portfolio return implied by the CAPM given the exposure of the portfolio to the market portfolio.
e. None of the above. The CAPM can be used to evaluate individual stocks but not funds.

Answer 1

Jensen’s Alpha, also known as the Jensen’s Performance Index, is a measure of the excess returns earned by the portfolio compared to returns suggested by the CAPM model.

It represents by the symbol Alpha ‘α’. The value of the excess return may be positive, negative, or zero.

The CAPM model itself provides risk-adjusted returns, i.e., it takes into account the risk of the security. So, Alpha = 0 indicates that the security is fairly priced and its actual returns will be same as CAPM.

So, The return of the portfolio is equal to the portfolio return implied by the CAPM given the exposure of the portfolio to the market portfolio.