Risk Premium

What Does Risk Premium Mean?
The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is a form of compensation for investors who tolerate the extra risk - compared to that of a risk-free asset - in a given investment.

Investopedia explains Risk Premium
Think of a risk premium as a form of hazard pay for your investments. Just as employees who work relatively dangerous jobs receive hazard pay as compensation for the risks they undertake, risky investments must provide an investor with the potential for larger returns to warrant the risks of the investment.

For example, high-quality corporate bonds issued by established corporations earning large profits have very little risk of default. Therefore, such bonds will pay a lower interest rate (or yield) than bonds issued by less-established companies with uncertain profitability and relatively higher default risk.

Related Terms

Default Risk
Dynamic Gap
Earnings Yield
Eat Well, Sleep Well
Risk Discount
Risk Tolerance
Risk-Adjusted Return
Risk-Free Rate of Return
Risk-Free Rate Puzzle - RFRP
Risk-Return Tradeoff
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Related Links

An Overview Of The Equity Risk Premium - Learn how the expected extra return on stocks is measured and why academic studies usually estimate a low premium.
Calculating The Equity Risk Premium - See the model in action with real data and evaluate whether its assumptions are valid.
How Interest Rates Affect The Stock Market - Whether you're buying lunch, a home or a stock, you're influenced by interest rates.
Projected Returns: Honing The Craft - We look at how to forecast long-term returns on the three major asset classes.
The Impact Of An Inverted Yield Curve - Find out what happens when short-term interest rates exceed long-term rates.
Catch On To The CCAPM - This model smooths over some of CAPM's weaknesses to make sense of risk aversion.
The Bond Market: A Look Back - Find out how fixed-income investments evolved in the past century and what it means today.
What are the components of the risk premium for investments?
What is happening during a risk repricing?

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