What is the Equity Risk Premium?

Equity Risk Premium...AKA ERP

Dictionary Definition

Equity Risk Premium (ERP) is defined as the extra yield that can be earned over the risk-free rate by investing in the stock market. 

Plain English

The equity risk premium is based on the idea of the risk-reward tradeoff. As a forward-looking quantity, the equity-risk premium is theoretical and cannot be known precisely, since no one knows how a particular stock, a basket of stocks or the stock market as a whole will perform in the future. It can be estimated as a backward-looking quantity by observing stock market and government bond performance over a defined period of time, for example, from 1970 to the present. Estimates, however, vary wildly depending on the time frame and method of calculation.

Duff & Phelps has published its recommended U.S. ERP and corresponding risk-free rate since 2008 and is a great resource.

Why it Matters to You

This is used in calculating the WACC.