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.

VIDEO

Loading the player...
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. Coskewness

    A statistical measure that calculates the symmetry of a variable's ...
  4. Beta

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

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

    The chance that an investment's actual return will be different ...
RELATED FAQS
  1. What is the historical market risk premium?

    The historical market risk premium is the difference between what an investor expects to make as a return on an equity portfolio ... Read Full Answer >>
  2. How does money supply affect interest rates?

    All else being equal, a larger money supply lowers market interest rates. Conversely, smaller money supplies tend to raise ... Read Full Answer >>
  3. What is the formula for calculating the capital asset pricing model (CAPM)?

    The capital asset pricing model, or CAPM, is a calculation used in corporate finance to determine the projected return generated ... Read Full Answer >>
  4. How do you calculate the geometric mean to assess portfolio performance?

    The geometric mean is used to calculate the central tendency of a set of numbers. It is the average of the logarithmic values ... Read Full Answer >>
  5. How much of a diversified portfolio should be invested in the electronics sector?

    The electronics sector tracks closely with the broader market, making it a cyclical sector with average volatility. Electronics ... Read Full Answer >>
  6. What are some common questions an interviewer may ask during an interview for a position ...

    When interviewing for a job at an investment bank, a candidate is likely to answer questions about his career and education ... Read Full Answer >>
Related Articles
  1. Investing

    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. Investing

    The Advantages Of Bonds

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

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  4. 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.
  5. Options & Futures

    Financial Concepts

    Diversification? Optimal portfolio theory? Read this tutorial and these and other financial concepts will be made clear.
  6. Investing Basics

    Treasury Inflation-Protected Securities (TIPS)

    Treasury inflation-protected securities are treasury securities that make adjustments for inflation as reflected in the Consumer Price Index.
  7. Fundamental Analysis

    Explaining Expected Return

    The expected return is a tool used to determine whether or not an investment has a positive or negative average net outcome.
  8. Mutual Funds & ETFs

    U.S. Investors Are Seeking Opportunities Overseas

    A latest analysis leads to believe that many investors are applying a spring cleaning approach to their portfolios, rebalancing as the 1st quarter ended.
  9. Investing

    Three Portfolio Moves To Consider Now

    What portfolio moves should you consider making as the 2nd quarter kicks off? Before we focus on the future, let’s first reflect on the 1st Q surprises.
  10. Investing Basics

    Manage Investments And Modern Portfolio Theory

    Modern Portfolio Theory suggests a static allocation which could be detrimental in declining markets, making it necessary for continuous risk assessment. Downside risk protection may not be the ...

You May Also Like

Hot Definitions
  1. Fisher Effect

    An economic theory proposed by economist Irving Fisher that describes the relationship between inflation and both real and ...
  2. Fiduciary

    1. A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets ...
  3. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  4. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  5. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  6. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
Trading Center