Market Risk Premium

See: Market RIsk.

Assume you put your money in a risk-free investment (no such thing really exists, but the closest an investment comes in reality is usually U.S. treasury bonds). What is the return on that investment?

Putting it into big-question terms: what is the amount of profit you can make without taking any risk?

Okay, now look at a market portfolio. It represents a precise snapshot of the financial markets. What is the return you can expect from this portfolio? How much money can you make by getting a little risky, and getting involved in financial markets?

Finally, look at the difference between the two returns. Subtract the risk-free return from the return on the market portfolio. That figure provides the market risk premium. It's the amount of extra return you get for taking a market-average risk versus what you could earn by socking your money away in the safest possible spot.