The equity risk premium is the additional return investors expect to earn from holding stocks instead of risk-free government bonds. It compensates them for the extra risk of equities. In the CAPM, it is the market return minus the risk-free rate, then scaled by a stock's beta.
Worked example
If investors expect the broad stock market to return 9% and the risk-free rate is 4%, the equity risk premium is 5%.
Why it matters
The premium is the reward for taking equity risk. Estimates commonly fall in a 4%–6% range, but it is not directly observable, so reasonable analysts disagree — which is one reason two valuations of the same company can differ.
Frequently asked questions
No. It is an estimate that shifts with market conditions and the method used. Analysts often use a long-run historical average as a stable input.