A tool used in financial analysis quantifies the difference between an asset’s actual return and its expected return, given market conditions. For example, if a stock earns 10% while the market benchmark returns 5%, and the stock’s expected return based on its beta is 6%, the difference (10% – 6% = 4%) represents its excess performance. This difference is crucial for evaluating investment strategies and manager performance.
Calculating this differential provides valuable insights into market inefficiencies, the impact of specific events, and the skill of portfolio managers. Historically, identifying these deviations has played a significant role in developing trading strategies and understanding market behavior. This analytical approach is especially relevant in event studies, where the impact of corporate actions like mergers and acquisitions or earnings announcements is assessed.
