1. Investment evaluation.
In the context of investment evaluation, the concept of alpha divides professional opinion.
One interpretation of alpha is that it is the portion of an investment’s total return arising from specific (that is non-market) risk.
It is a measure of the difference between the actual historic return from an investment, and the expected performance arising from exposure to market risk factors.
Also known as the 'error term'.
An investment producing 'positive alpha' is one performing better than a benchmark with the same market risk.
Practitioners who are sceptical about alpha warn of the risks of attributing historic outperformance - in error - to the skills of company managements, or of the investment managers who selected the investments to incorporate into a portfolio, in circumstances where the outperformance may not be representative of the likely future performance.
2. Bank supervision - capital adequacy - operational risk.
Under the Basic Indicator Approach (BIA) calculation for operational risk capital adequacy, alpha is the weighting applied to gross income, to calculate the measure of risk.
This weighting factor is also sometimes known as 'beta'.