How Do You Calculate A Market Risk Premium?
The ideal investment is no risk and all gain. However, finding this elusive investment is akin to searching for a pot of gold. Most investment managers settle for achieving gains above the risk-free rate. Market risk premium is the difference between the risk-free rate and expected returns on the market. Investors use it as a way to price assets. In fact, it represents the slope of the most popular capital asset pricing model (for all the math nerds). The calculation is easy; the challenge is determining a proxy or an estimation for the different variables within the formula. Review the market risk premium formula. Market risk premium = expected market return – risk-free rate. Determine the “risk-free” rate of return. Treasuries are considered to be risk free as they are backed by the “full faith and credit” of the U.S. government. For this reason, we can use them as a proxy for the risk-free rate. Look up the 10-year treasury yield. The Federal Reserve Bank (FRB) publishes updated tre
