What Is Market Risk Premium?
When it comes to investing, you can choose levels of risk. The market risk premium measures the level of return expected when making investments that are considered more risky than the safest investment.
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Risk-Free Rate
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To complete the calculation, you must know the risk-free rate, which is usually based on Treasury Bills because they are considered to be very safe investments.
Market Return
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The market return of a portfolio is the return that you can expect to receive based on the market as a whole or a specific portfolio. Assuming that it includes riskier investments than Treasury Bills, the market return will likely be higher than the risk-free rate.
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Benefits
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The benefit of a risk premium is shown by subtracting the market return from the risk-free rate. For instance, if the risk-free rate is 3 percent and the market return is 8 percent, the risk premium would be 5 percent. This is essentially the reward for an investor's risk.
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References
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