What it is
The equity risk premium (ERP) is the additional return investors expect to receive for taking on the higher risk of investing in equities compared to a risk-free asset, typically a government bond yield. It represents the compensation for bearing the volatility, illiquidity, and potential for capital loss associated with stocks. A higher ERP suggests stocks are more attractive relative to bonds, while a lower ERP implies less compensation for equity risk.
The ERP is a crucial concept for institutional investors and financial models, influencing asset allocation decisions. When the ERP is high, it can signal that stocks are undervalued or that investors are overly pessimistic, potentially indicating a buying opportunity. Conversely, a low ERP suggests stocks may be overvalued or that investors are excessively optimistic. Changes in interest rates and corporate earnings expectations significantly impact the ERP.
Why it matters
The ERP helps you assess if stocks are attractively valued compared to safer investments like bonds. A high ERP suggests better potential returns for taking equity risk.
Reviewed under editorial standardsUpdated September 26, 2026Not investment advice