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Rekenthaler Report

What's Alpha?

These days, the statistic's interpretation is taken more figuratively than literally.

The Statistic is Born
The conclusion of Friday’s column deserves further consideration. Alpha is among the most common of investment terms. It is also among the most confusing, given its multiple meanings. Today’s column will disentangle the threads.

The expression originated in 1967, appearing in “The Performance of Mutual Funds in the Period 1945-1964,” by Michael Jensen. (Consequently, alpha is sometimes called by traditionalists “Jensen’s Alpha.”) It was a mathematical result, providing the intercept on the y axis for a best-fit line--defined as alpha’s counterpart, beta, which describes a fund’s level of risk--on a scatterplot that places stock market performance on the x-axis and the fund’s totals on the y-axis.

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