The Equity Risk Premium

The equity (aka market) risk premium is the average expected extra return that shareholders might expect to earn by investing in shares versus bonds. Since government bonds are (almost) risk-free, it follows that equity investors, taking on market risk, should earn a premium. This is the essence of the Capital Asset Pricing Model which states that Ri = RfR + Betai*MRP (the expected return on share i = the return on 10 year government bonds + the share i's beta times the market risk premium). We discuss the issues around estimating the MRP.