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

An analyst finds that a strategy earns a positive CAPM alpha, but the alpha disappears when value and momentum factors are added to the regression. What is the most appropriate conclusion?

The CAPM alpha mostly represented compensation for exposure to other systematic factors such as value and momentum. Once those factors are controlled for, the unexplained return falls to zero, so it was not evidence of manager skill.

  1. AThe CAPM alpha largely reflected compensation for exposure to other systematic factors rather than skillCorrect
  2. BThe strategy has a true alpha that is larger than measured under CAPM
  3. CThe CAPM beta must have been negative
  4. DThe multi-factor model is invalid because it reduced alpha

Explanation

If alpha vanishes once additional factors are included, the earlier alpha was a return from factor exposures (smart beta) that the single-factor CAPM failed to capture. It does not indicate skill, nor invalidate the model, and says nothing about a negative beta.

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