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

A manager's monthly returns are regressed on the market excess return and the regression gives an intercept of 0.20% per month with a t-statistic of 0.9. Which interpretation is most appropriate?

The alpha is not statistically significant, so skill cannot be concluded. A t-statistic of 0.9 is well below about 2, meaning the positive 0.20% monthly intercept is consistent with random noise rather than demonstrated manager skill.

  1. AThe manager has demonstrated significant skill because the intercept is positive
  2. BThe alpha estimate is not statistically distinguishable from zero, so skill cannot be concludedCorrect
  3. CThe manager's beta is 0.20, indicating low market exposure
  4. DThe manager's tracking error must be zero

Explanation

A t-statistic of 0.9 is well below the roughly 2 needed for significance at conventional levels. A positive point estimate can arise from luck or noise. The intercept is alpha, not beta, and says nothing about tracking error being zero.

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