What is 'Market Risk Premium'
The market risk premium is the difference between the expected return on a market portfolio and the riskfree rate. The market risk premium is equal to the slope of the security market line (SML), a graphical representation of the capital asset pricing model (CAPM). CAPM measures required rate of return on equity investments, and it is an important element of modern portfolio theory and discounted cash flow valuation.
Market risk premium describes the relationship between returns from an equity market portfolio and treasury bond yields. The risk premium reflects required returns, historical returns and expected returns. 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.
Theory
Investors require compensation for risk and opportunity cost. The riskfree rate is a theoretical interest rate that would be paid by an investment with zero risk, and longterm yields on U.S. treasuries have traditionally been used as a proxy for the riskfree rate because of the low default risk. Treasuries have historically had relatively low yields as a result of this assumed reliability. Equity market returns are based on expected returns on a broad benchmark index such as the Standard & Poor's 500 index of the Dow Jones Industrial Average. Real equity returns fluctuate with operational performance of the underlying business, and the market pricing for these securities reflects this fact. Historical return rates have fluctuated as the economy matures and endures cycles, but conventional knowledge has generally estimated longterm potential of approximately 8% annually. As of 2016, some economists are calling for a reduction in this assumed rate, though opinions on the topic diverge. Investors demand a premium on their equity investment return relative to lower risk alternatives because their capital is more jeopardized, which leads to the equity risk premium.
Calculation and Application
The market risk premium can be calculated by subtracting the riskfree rate from the expected equity market return, providing a quantitative measure of the extra return demanded by market participants for increased risk. Once calculated, the equity risk premium can be used in important calculations such as CAPM. Between 1926 and 2014, the S&P 500 exhibited a 10.5% compounding annual rate of return, while the 30day treasury bill compounded at 5.1%. This indicates a market risk premium of 5.4%, based on these parameters.
The required rate of return for an individual asset can be calculated by multiplying the asset's beta coefficient by the market coefficient, then adding back the riskfree rate. This is often used as the discount rate in discounted cash flow, a popular valuation model.
BREAKING DOWN 'Market Risk Premium'

Risk Premium
A risk premium is the return in excess of the riskfree rate ... 
RiskFree Asset
A riskfree asset is an asset which has a certain future return ... 
Equity Risk Premium
Equity risk premium refers to the excess return that investing ... 
International Capital Asset Pricing ...
The international capital asset pricing model (CAPM) is a financial ... 
Abnormal Return
A term used to describe the returns generated by a given security ... 
Required Rate Of Return  RRR
The required rate of return is the minimum return an investor ...

Investing
Understanding Market Risk Premium
Market risk premium is equal to the expected return on an investment minus the riskfree rate. The riskfree rate is the minimum rate investors could expect to receive on an investment if it ... 
Investing
How to Calculate Risk Premium
Think of a risk premium as a form of hazard pay for risky investments. 
Investing
The Capital Asset Pricing Model: an Overview
CAPM helps you determine what return you deserve for putting your money at risk. 
Investing
Calculating the Equity Risk Premium
See the model in action with real data and evaluate whether its assumptions are valid. Here is how to calculate the equity risk premium. 
Investing
How Risk Free Is the RiskFree Rate of Return?
This rate is rarely questioned—unless the economy falls into disarray. 
Investing
The EquityRisk 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. 
Financial Advisor
Measure Your Portfolio's Performance
Measuring the success of your investment solely on the portfolio return may leave you blindsided to risk. Learn how to evaluate your investment return. 
Tech
CAPM vs. Arbitrage Pricing Theory: How They Differ
Both project the expected rate of return given the level of risk assumed, but they consider different variables.

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 >> 
How do I calculate the equity risk premium in Excel?
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What is the difference between cost of equity and cost of capital?
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How is bond yield affected by monetary policy?
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According to the CAPM, the expected return on a stock, that is part of a portfolio, ...
A. the covariance between the stock and the market. B. the variance of the market. C. the market risk premium. D. ... Read Answer >> 
How do you calculate the excess return of an ETF or indexed mutual fund?
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