Calculating Equity Risk Premium
The market return is 8% and the risk-free rate is 2%.
- market_return:
- 8%
- risk_free_rate:
- 2%
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Equity Risk Premium
Equity risk premium is the additional return expected over the risk-free rate.
Deep dive
Equity risk premium represents the additional return investors require for investing in equities over risk-free assets. It is calculated as the difference between the expected market return and the risk-free rate. Equity risk premium is a key component of the CAPM model for calculating the cost of equity. It differs from the total expected return as it only considers the surplus over the risk-free rate.
Key formula
Equity Risk Premium = Market return - Risk-free rate
Real-world examples
Pitfalls to avoid
- Using a risk premium based on irrelevant historical data.
- Ignoring economic changes affecting market expectations.
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