Calculate Jensen’s Measure to Evaluate Portfolio Performance

By Stock Research Pro • October 18th, 2009

Jensen’s Measure or “Jensen’s Alpha” is a measure of the risk-adjusted performance of a portfolio beyond the return forecasted by the capital asset pricing model (CAPM). Introduced in the 1970s by Michael Jensen, the measure can be used for a number of assets, including stocks, bonds, or derivatives. The theory behind Jensen’s measure is that, when evaluating portfolio performance, the risk needs to be considered along with the overall return.


About the Capital Asset Pricing Model

The Capital Asset Pricing Model (CAPM) is used to predict the expected return of a stock or another type of asset. The CAPM calculation accounts for both the time value of money and risk to arrive at an expected return. The CAPM is often used to build a discount rate into a valuation model.


Calculate Jensen’s Measure

The formula for Jensen’s Measure can be written as:


Jensen’s Measure = rp – [rf + bp (rm – rf)]

Where:

rp = expected portfolio return
rf = risk free rate of return
bp = portfolio beta
rm = expected market return

Jensen’s Measure provides a tool to help investors determine whether a portfolio is earning an appropriate level of return, given the risk of that portfolio. In assessing the measure, a positive value indicates that the portfolio is exceeding expectations.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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