Equity Risk Premium

Glossary

Banking

Equity Risk Premium

The equity risk premium (ERP) is the minimum return investors should demand to compensate them for the risk exposure of an equity portfolio over and above risk-free real bond yields. In essence, investors use the ERP as a proxy for how much the stock market (i.e. a stock index) is expected to outperform inflation-linked government bonds. The ERP is widely used to determine asset pricing, cost of capital and savings choices. It is seen by some as a leading indicator of economic performance, since research shows that a high ERP typically precedes higher economic growth (and higher inflation). By the same token, a high ERP may be the result of low risk-free rates rather than high expected equity returns based on future earnings or dividends.

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