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The Credibility of the Jensen's Performance Index

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Where did the Jensen Measure come from and why is it not commonly used?

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According to Jensen's alpha (2010) the Jensen's alpha or Jensen's performance index is used to determine the abnormal return of a security or portfolio of securities over the theoretical expected return. According to this site, the security could be any asset, such as stocks, bonds or derivatives. The theoretical return is predicted by a market model, known as the Capital Asset Pricing Model (CAPM) model. In addition, according to this author, the market model uses statistical methods to predict the appropriate risk-adjusted return of an asset. For example, the CAPM uses beta as a multiplier.

According to Jensen's alpha site (2010), within the context of CAPM, calculating alpha requires the following inputs: the ...

Solution Summary

This paper examines the notion of the Jensen's alpha or Jensen's performance index. This index is used to determine the abnormal return of a security or portfolio of securities with respect to the theoretical expected return. This paper discusses several reasons why the Jensen's model is not utilized as much today, in that many academics believe financial markets are too efficient to allow for repeately earning positive alpha, unless by chance; however empirical studies of mutual funds have shown that usually confirm managers' stock-picking talent; that is finding positive alpha. In addition, the Jensen measure is also based on CAPM (Capital Asset Pricing Model) and it calculates the excess return that a portfolio generates over its expected return.