What Does Market Risk Premium mean?

Market Risk Premium refers to the expected return on a risk asset, minus the risk-free rate.

A good barometer for the risk-free rate is using a U.S. Treasury bond, which is largely considered a risk-less asset if held to maturity. To give an example, let’s say the annual expected return on Stock ABC is 11%, and a 1-year U.S. Treasury pays 2%. In this case, the market risk premium is the difference between the two, or 9%.

Often times, the market risk premium is used in the context of an equity index, like the S&P 500, versus U.S. Treasuries.

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