How Do You Find The Market Risk Premium?
Investors want two things: high returns and no risk. The market risk premium brings these two concepts together; it is any return over the risk-free rate. The risk-free rate is defined as the return an investor can expect on an investment with no risk, but what does this mean? Is there such a thing as an investment with no risk? If so, can you use it to find the market risk premium? The answer is yes. Understand the concept. Market risk premium is a function of supply and demand. When in equilibrium, there is no need to pay a premium; that is, supply is in line with demand. If demand increases, and supply cannot meet demand, the price for that asset goes up. The price difference is the premium. Market risk premium is the price difference over the risk equilibrium. How do you find the risk equilibrium? Define risk equilibrium or the risk-free rate. The most “risk-free” asset is debt from the United States government. That is, there is very little chance that the government of the United
