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

A manager's fund has a monthly regression against the market excess return giving an intercept of 0.20% per month with a standard error of 0.15%, based on 60 months. Which conclusion is most appropriate?

The alpha annualizes to about 2.4%, but the t-statistic is roughly 1.33, below the approximate 2.0 needed at the 5% level. The data therefore do not reliably distinguish skill from luck, so the alpha should not be treated as statistically established.

  1. AThe alpha is annually about 2.4% and is statistically significant at the 5% level
  2. BThe alpha is annually about 2.4% but its t-statistic of about 1.33 does not establish skill at the 5% levelCorrect
  3. CThe alpha is annually about 0.2% and is insignificant
  4. DThe alpha is zero because the regression intercept is below 1%

Explanation

The t-statistic is 0.20/0.15 = 1.33, below roughly 2.0 critical value, so the estimate is not significant. Annualizing 0.20% x 12 gives about 2.4%. Treating it as significant ignores estimation error.

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