What does Jensen's alpha measure in portfolio management?

Jensen's alpha is a metric that quantifies the performance of an investment portfolio relative to a benchmark, adjusting for the risk taken. Specifically, it measures the actual return of a portfolio minus the expected return predicted by the Capital Asset Pricing Model (CAPM), which is based on the portfolio's beta (a measure of its volatility relative to the market).

When a portfolio's return exceeds the expected return, this indicates that the portfolio manager has added value through superior investment selection or other management decisions, outperforming what would typically be expected given the level of market risk taken. Therefore, Jensen's alpha captures performance attributed to active management rather than market exposure.

In this context, while the other choices might relate to different aspects of portfolio management, they do not specifically encapsulate the essence of Jensen's alpha, which is focused distinctly on the difference between actual and expected returns based on market risk. Thus, it is clear why the measure of actual return minus expected return based on beta accurately defines Jensen’s alpha in portfolio management.