A Risk Premium is the amount by which the expected return on a risky asset exceeds the risk-free rate of return. The risk-free rate of return is the return that can be earned on an investment with zero risk, such as a U.S. Treasury bond.The risk premium reflects the compensation that investors require for taking on the additional risk of investing in a risky asset, such as a stock or a corporate bond. It is calculated by subtracting the risk-free rate from the expected return on the risky asset.For example, if the risk-free rate is 2% and the expected return on a stock is 8%, the risk premium for the stock would be 6%. This means that investors expect to earn an additional 6% return on the stock above the risk-free rate in exchange for the additional risk they are taking on.Risk premiums can vary significantly depending on the type of asset and the level of risk involved. Higher risk assets, such as stocks, are typically associated with higher risk premiums, while lower risk assets, such as Treasury bonds, are associated with lower risk premiums. Risk premiums can also vary over time depending on changes in market conditions and investor sentiment.
