Equity Risk Premium

AAA

DEFINITION of 'Equity Risk Premium'

The excess return that an individual stock or the overall stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk of the equity market. The size of the premium will vary as the risk in a particular stock, or in the stock market as a whole, changes; high-risk investments are compensated with a higher premium.

Also referred to as "equity premium".

INVESTOPEDIA EXPLAINS 'Equity Risk Premium'

The reason behind this premium stems from the risk-return tradeoff, in which a higher rate of return is required to entice investors to take on riskier investments. The risk-free rate in the market is often quoted as the rate on longer-term government bonds, which are considered risk free because of the low chance that the government will default on its loans. On the other hand, an investment in stocks is far less guaranteed, as companies regularly suffer downturns or go out of business.

If the return on a stock is 15% and the risk-free rate over the same period is 7%, the equity-risk premium would be 8% for this stock over that period of time.

RELATED TERMS
  1. International Capital Asset Pricing ...

    A financial model that extends the concept of the capital asset ...
  2. Equity

    1. A stock or any other security representing an ownership interest. ...
  3. Premium

    1. The total cost of an option. 2. The difference between the ...
  4. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
  5. Risk

    The chance that an investment's actual return will be different ...
  6. Risk-Return Tradeoff

    The principle that potential return rises with an increase in ...
Related Articles
  1. Why Stocks Outperform Bonds
    Bonds & Fixed Income

    Why Stocks Outperform Bonds

  2. The Capital Asset Pricing Model: An ...
    Fundamental Analysis

    The Capital Asset Pricing Model: An ...

  3. Calculating The Equity Risk Premium
    Options & Futures

    Calculating The Equity Risk Premium

  4. The Equity-Risk Premium: More Risk For ...
    Fundamental Analysis

    The Equity-Risk Premium: More Risk For ...

Hot Definitions
  1. Conduit Issuer

    An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects ...
  2. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  3. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  4. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  5. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  6. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
Trading Center