The market risk premium
By SuperdayReps · Wharton MBA · ex-Greenhill · investment banking interview coaching
4 min read · updated July 2, 2026
The market risk premium is the extra return investors demand for putting money in the stock market instead of a risk-free government bond. It's the market's price of risk. Stocks can lose money; Treasuries basically can't, so nobody would hold stocks unless they paid more on average. That "more" is the market risk premium.
You'll hear it called the equity risk premium too. Same thing: the reward for bearing the risk of the whole equity market. In the formulas it shows up as , the market return minus the risk-free rate.
Where it sits in CAPM
It's the middle piece of CAPM:
Read that structure carefully, because it's the whole point. The market risk premium is the reward for holding the entire market. Beta then scales that reward up or down for one specific stock. A beta of 1.5 earns 1.5 times the market premium; a beta of 0.6 earns 0.6 times it.
On any given day, the market risk premium (and the risk-free rate) is the same for every company you value. Beta is the only input that changes company to company. So when two firms have different costs of equity, beta is doing all the work, but the market risk premium sets the scale of the whole thing. Bump it a point and every company's cost of equity rises.
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Frequently asked
- What is the market risk premium?
- The market risk premium is the extra return investors demand for holding stocks instead of a risk-free government bond. It is the market's price of risk. Stocks can lose money and Treasuries basically cannot, so nobody would hold stocks unless they paid more on average. It shows up as market return minus the risk-free rate.
- What is a reasonable equity risk premium to use?
- Call it 5 to 7 percent, roughly the long-run spread of US stocks over government bonds, and that historical average anchors most estimates. Most banks have a house number they use across every deal. In an interview, know the range and use the desk's figure rather than inventing your own on the spot.
- What is the difference between the market risk premium and the market return?
- The market risk premium is the spread over the risk-free rate, not the total expected return on stocks. If someone hands you an expected market return of 9 percent and a risk-free rate of 3 percent, the premium is 6 percent, not 9 percent. Confusing the two is the classic slip.
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