Jensens Alpha

The Jensen Performance Index is used to determine if the Required Return, calculated using the Capital Asset Pricing Model, is realized. The Capital Asset Pricing Model is used to determine the required rate of return (in order to assume the level of risk and the Jensen Performance index is used to see if the calculation yielded the results that you thought that it would.

In order to use the Jensen Performance Index, you will need the following; the realized return (on the portfolio), the market rate of return, the tax-free rate of return and the beta of the portfolio.

For those of you who want to know the formula for the index;

Jensens = Portfolio Return - [Risk-free return + (Market Return - Risk-free Return) * Beta]

As an example, a portfolio manager achieved a return of 15.0%, his portfolio had beta measurement of 1.1 and the market achieved a return of 14.6% vs. a risk free rate of return of 7%. To calculate the Jensen Index:

alpha = .15 - [ .07 + (.146 - .07) * 1.1 ] = -.0036

a negative number indicates inferior performance as compared to the risk.