Market Risk Premium

Loading the player...

What is '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.

BREAKING DOWN '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. Risk Premium

    The return in excess of the risk-free rate of return that an ...
  2. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  3. Earned Premium

    The amount of total premiums collected by an insurance company ...
  4. Amortizable Bond Premium

    A tax term referring to the excess premium paid over and above ...
  5. Net Premiums Written

    The sum of premiums written by an insurance company over the ...
  6. Written Premium

    An accounting term in the insurance business used to describe ...
Related Articles
  1. Managing Wealth

    Understanding Market Risk Premium

    Market risk premium is equal to the expected return on an investment minus the risk-free rate. The risk-free rate is the minimum rate investors could expect to receive on an investment if it ...
  2. Managing Wealth

    How to Calculate Risk Premium

    Think of a risk premium as a form of hazard pay for risky investments.
  3. Investing

    Calculating the Equity Risk Premium

    Equity risk premium is the excess expected return of a stock, or the stock market as a whole, over the risk-free rate.
  4. Managing Wealth

    Tactical Tips For Bond Investors

    Profit from long-term market trends by buying bonds when other investors shy away.
  5. Investing

    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.
  6. Managing Wealth

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  7. Markets

    Explaining Premiums

    Premium has a few different meanings in the financial world.
  8. Markets

    Risk-Free Rate of Return

    The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free ...
  9. Managing Wealth

    How Interest Rates Affect Property Values

    Along with their impact on mortgages, interest rates affect capital flows, the supply and demand for capital, and an investor’s required rate of return.
  10. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
RELATED FAQS
  1. What is the historical market risk premium?

    Learn what the historical market risk premium is and the different figures that result from an analyst's choice of calculations ... Read Answer >>
  2. Is market risk premium the same for all investors and investments?

    Learn about how market risk premiums are determined, how they are calculated, why some assets require higher premiums and ... Read Answer >>
  3. Is the market risk premium the same for stocks and bonds?

    Take a look at historical equity risk premium and credit spreads in the United States, which suggest that equities carry ... Read Answer >>
  4. How is the expected market return determined when calculating market risk premium?

    Find out how the expected market return rate is determined when calculating market risk premium and how these figures are ... Read Answer >>
  5. How accurate is the equity risk premium in evaluating a stock?

    Learn about the drawbacks of using the equity risk premium to evaluate a stock, and understand how it is calculated using ... Read Answer >>
  6. What is the correlation between equity risk premium and risk?

    Learn about the relationship between the risk-free rate of return and the equity risk premium, and understand how the risk-free ... Read Answer >>
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center