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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A fund has a beta of 0.8 to the market. Monthly regression of its excess returns on market excess returns gives an intercept of 0.20% per month. The annualised risk-free rate is ignored for this question, and the intercept is treated as a simple monthly sum over 12 months. What is the best interpretation of this result?

The intercept is alpha, the average return not explained by market beta. A 0.20% monthly alpha scales to roughly 2.4% a year. It is a return component, not market-driven return and not a measure of idiosyncratic risk.

  1. AAnnualised alpha of about 2.4%, the return not explained by market exposureCorrect
  2. BAnnualised alpha of 0.20%, since alpha is not scaled over time
  3. CAnnual market-driven return of 2.4%, due to the fund's beta
  4. DAnnualised idiosyncratic risk of 2.4%

Explanation

The regression intercept is alpha, the return unexplained by market beta. Over 12 months, 0.20% x 12 = 2.4% approximately. It is a return measure, not a risk measure, and it is not the beta-driven component.

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