Excess Return

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Definition: Excess Return

Securities with similar risk are expected to earn similar returns and higher the risk, higher is the expected return. A security/portfolio is said to make excess return if it makes more return than securities of similar risk. The securities are generally compared with a benchmark or an index (like S&P 500 index) with similar risk.

According to CAPM Capital Asset Pricing Model:

Formula

R i = R RF + RP m * b i

Where:

R : expected return on security i

R RF  : Risk free rate of return

RP m: Market risk premium

bI : Beta for security i

If the return earned is greater than the expected return R, excess returns have been realized.

Excess return is also sometimes referred as the excess return made over the risk free rate of return over a period of time.

 

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