Market Risk Premium

AAA

DEFINITION of 'Market Risk Premium'

The difference between the expected return on a market portfolio and the risk-free rate. Market risk premium is equal to the slope of the security market line (SML), a capital asset pricing model. Three distinct concepts are part of market risk premium:
1) Required market risk premium: the return of a portfolio over the risk-free rate (such as that of treasury bonds) required by an investor;


2) Historical market risk premium: the historical differential return of the market over treasury bonds; and


3) Expected market risk premium: the expected differential return of the market over treasury bonds.


Also called equity premium, market premium and risk premium.

INVESTOPEDIA EXPLAINS 'Market Risk Premium'

The historical market risk premium will be the same for all investors since the value is based on what actually happened. The required and expected market premiums, however, will differ from investor to investor based on risk tolerance and investing styles. The market risk premium can be calculated as follows:
Market Risk Premium = Expected Return of the Market – Risk-Free Rate


The expected return of the market can be based on the S&P 500, for example, while the risk-free rate is often based on the current returns of treasury bonds.

RELATED TERMS
  1. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. ...
  2. Systematic Risk

    The risk inherent to the entire market or entire market segment. ...
  3. Beta

    A measure of the volatility, or systematic risk, of a security ...
  4. Market Risk

    The possibility for an investor to experience losses due to factors ...
  5. Risk

    The chance that an investment's actual return will be different ...
  6. Coskewness

    A statistical measure that calculates the symmetry of a variable's ...
Related Articles
  1. Investing

    The Advantages Of Bonds

    Bonds contribute an element of stability to almost any portfolio and offer a safe and conservative investment.
  2. Fundamental Analysis

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  3. Fundamental Analysis

    The Equity-Risk Premium: More Risk For Higher Returns

    Learn how the expected extra return on stocks is measured and why academic studies usually estimate a low premium.
  4. Options & Futures

    Financial Concepts

    Diversification? Optimal portfolio theory? Read this tutorial and these and other financial concepts will be made clear.
  5. Mutual Funds & ETFs

    What types of fees are incurred by purchasing ETFs?

    Understand all the various costs, both explicit and hidden, involved in trading exchange-traded funds, or ETFs, and see how their costs compare to fund trading costs.
  6. Bonds & Fixed Income

    What is the difference between a debenture and a bond?

    Learn how to differentiate between debentures and bonds, two types of debt securities that can be issued by a government or company to raise capital.
  7. Mutual Funds & ETFs

    What ETFs can I buy that track the telecommunication sector?

    Get information about some of the most popular and highly traded ETFs that investors use to track the telecommunications market sector.
  8. Mutual Funds & ETFs

    Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your investment portfolio.
  9. Investing Basics

    What does the end of the quarter mean for portfolio management?

    Take a deeper look at why the end of a financial quarter, and all of its accompanying reports, is a significant event for portfolio management.
  10. Promising high yields that the Eurozone and U.S. can't match, West African sovereign debt has caught the attention of savvy investors.
    Bonds & Fixed Income

    Interested In West African Debt? Look Here First

    Promising high yields that the Eurozone and U.S. can't match, West African sovereign debt has caught the attention of savvy investors.

You May Also Like

Hot Definitions
  1. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would ...
  2. Scarcity

    The basic economic problem that arises because people have unlimited wants but resources are limited. Because of scarcity, ...
  3. Trust Fund

    A trust fund is a fund comprised of a variety of assets intended to provide benefits to an individual or organization. The ...
  4. Christmas Tree

    An options trading strategy that is generally achieved by purchasing one call option and selling two other call options at ...
  5. Christmas Club

    A short-term savings account that usually pays out the full account balance to its account holders once each year, right ...
  6. Boston Snow Indicator

    A market theory that states that a white Christmas in Boston will result in rising stock prices for the following year. For ...
Trading Center