Jensen’s alpha (aka Jensen index), developed by Michael C. Jensen, uses the capital asset pricing model (CAPM) to determine the amount of the return that is firm-specific over that which is due to market risk, which causes market volatility as measured by the firm’s beta.Jensen’s Alpha = Total Portfolio Return – Risk-Free Rate – [Portfolio Beta x (Market Return – Risk-Free Rate)]
Jensen’s alpha can be positive, negative, or zero. Note that, by definition, Jensen’s alpha of the market is zero. If the alpha is negative, then the portfolio is underperforming the market.