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.


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.

  1. Standard Deviation

    1. A measure of the dispersion of a set of data from its mean. ...
  2. Type I Error

    A type of error that occurs when a null hypothesis is rejected ...
  3. Mean

    The simple mathematical average of a set of two or more numbers. ...
  4. Hypothesis Testing

    A process by which an analyst tests a statistical hypothesis. ...
  5. Monte Carlo Simulation

    A problem solving technique used to approximate the probability ...
  6. Type II Error

    A statistical term used within the context of hypothesis testing ...
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