Excess Returns are defined as returns above what?

Excess returns are defined as the returns achieved above the risk-free rate of return. This concept is fundamental in finance as it provides a benchmark for evaluating the performance of an investment. The risk-free rate represents the return on an investment that is considered free of risk, typically associated with government bonds, such as U.S. Treasury bills.

By comparing actual returns to the risk-free rate, investors can determine how much additional return they are gaining by taking on the extra risk associated with a particular asset or portfolio. This measure is vital for assessing risk-adjusted returns and making informed investment decisions.

In contrast, while the historical average rate of return, sector average, and inflation rate are all important metrics, they do not serve as the benchmark for measuring excess returns in the same manner as the risk-free rate.