Alpha Risk

DEFINITION of 'Alpha Risk'

The risk in a statistical test that a null hypothesis will be rejected when it is actually true. This is also known as a Type I error. The best way to decrease alpha risk is to increase the size of the sample being tested with the hope that the larger sample will be more representative of the population.

BREAKING DOWN 'Alpha Risk'

An example of alpha risk in finance would be if one wanted to test the hypothesis that the average yearly return on a group of equities was greater than 10%. So the null hypothesis would be if the returns were equal to or less that 10%. In order to test this, one would compile a sample of equity returns over time and set the level of significance. If, after statistically looking at the sample, you determine that the average yearly return is higher than 10%, you would reject the null hypothesis. But in reality, the average return was 6% so you have made a type I error. The probability that you have made this error in your test is the alpha risk. This alpha risk could lead you to invest in a group of equities when the returns do not actually justify the potential risks.

RELATED TERMS
  1. Hypothesis Testing

    A process by which an analyst tests a statistical hypothesis. ...
  2. Type II Error

    A statistical term used within the context of hypothesis testing ...
  3. Null Hypothesis

    A type of hypothesis used in statistics that proposes that no ...
  4. Type I Error

    A type of error that occurs when a null hypothesis is rejected ...
  5. Beta Risk

    The probability that a false null hypothesis will be accepted ...
  6. Z-Test

    A statistical test used to determine whether two population means ...
Related Articles
  1. Trading

    Hypothesis Testing in Finance: Concept & Examples

    When you're indecisive about an investment, the best way to keep a cool head might be test various hypotheses using the most relevant statistics.
  2. Investing

    What is a Null Hypothesis?

    In statistics, a null hypothesis is assumed true until proven otherwise.
  3. Investing

    How Statistical Significance is Determined

    If something is statistically significant, it’s unlikely that it happened by chance.
  4. Investing

    Explaining Standard Error

    Standard error is a statistical term that measures the accuracy with which a sample represents a population.
  5. ETFs & Mutual Funds

    Alpha and Beta for Beginners

    An in-depth look at what alpha and beta are and what they measure.
  6. Markets

    How Does Sampling Work?

    Sampling is a term used in statistics that describes methods of selecting a pre-defined representative number of data from a larger data population.
  7. Markets

    What is Systematic Sampling?

    Systematic sampling is similar to random sampling, but it uses a pattern for the selection of the sample.
  8. Markets

    What is a Representative Sample?

    In statistics, a representative sample accurately represents the make-up of various subgroups in an entire data pool.
  9. Trading

    Bettering Your Portfolio With Alpha And Beta

    Increase your returns by creating the right balance of both these risk measures.
  10. Trading

    What's a T-Test?

    T-Test is a term from statistics that allows for the comparison of two data populations and their means. The test is used to see if the two sets of data are significantly different from one another. ...
RELATED FAQS
  1. What does a strong null hypothesis mean?

    Find out what null hypothesis is and why it is important to the scientific method. See how statisticians and economists use ... Read Answer >>
  2. What is the relationship between confidence inferrals and a null hypothesis?

    Learn about the relationship between confidence intervals and the null hypothesis in scientific research and empirical experimentation. Read Answer >>
  3. What percentage of the population do you need in a representative sample?

    Learn about representative samples and how they are used in conjunction with other strategies to create useful data with ... Read Answer >>
  4. How can a representative sample lead to sampling bias?

    Learn how using representative samples alone is not enough to make sampling bias negligible and why elements such as randomization ... Read Answer >>
  5. What's the difference between a representative sample and a convenience sample?

    Learn the difference between convenience sampling and representative sampling and the advantages and disadvantages of each ... Read Answer >>
  6. Does a negative alpha automatically mean I should sell?

    Learn how alpha is used to assess an investment's profitability relative to the broader market and why a negative value isn't ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center