How is the concept of Excess Returns typically measured?

Excess returns are typically understood as the returns on an investment that exceed the returns of a benchmark or a risk-free rate. When measuring excess returns, the most common approach is to compare them against the risk-free rate, which represents the return expected from a theoretically safe investment, such as U.S. Treasury bonds. This measurement allows investors to assess how much additional return they are earning relative to a no-risk scenario.

By using the risk-free rate as a baseline, investors can evaluate the performance of their investments in terms of the additional risks they are taking. This helps in understanding whether the return justifies the risk and aids in making informed investment decisions. This methodology is central to various financial concepts, including the Capital Asset Pricing Model (CAPM), where excess return serves as a fundamental measure for evaluating risk-adjusted performance.