Definition
The equity risk premium (ERP) is the additional return investors demand for holding stocks instead of risk-free assets. It compensates for the higher risk of equities. Historically, the ERP has averaged 4-6% annually. It's used in CAPM and DCF valuations to determine appropriate discount rates.
Formula
ERP = Expected Market Return - Risk-Free Rate
Example
If expected market return is 10% and risk-free rate is 4%, the equity risk premium is 6%.
FAQ
What is Equity Risk Premium?
The excess return investing in stocks provides over the risk-free rate.
How do you calculate Equity Risk Premium?
A common formula for Equity Risk Premium is: ERP = Expected Market Return - Risk-Free Rate
Why is Equity Risk Premium important?
Equity Risk Premium helps investors evaluate valuation and make more informed decisions.