Is Alpha Dead?

Abstract

We are said to live in an “Alpha-centric” world, in which investors supposedly focus on “Alpha”. This demand is met by active investment managers – “Alpha hunters”. This note does presents two conceptual arguments why Alpha does not automatically result in superior risk-adjusted returns and is not a suitable performance metric except for investors with an unlimited appetite for leverage. We also discuss why Alpha values estimated by performance analysts are prone to be distorted by specification errors. While Beta has been declared dead several times in the past, Alpha seems to be a survivor. The diagnosis implicit in this note is that Alpha is in a very critical condition in the most optimistic interpretation of the arguments.

Keywords: Alpha Index, Factor Model, Portfolio Risk, Adjusted Performance Measure