What is high equity risk premium

The equity risk premium is the excess return above the risk-free rate that you can get for investing in an individual stock. The premium you can get is directly correlated with the riskiness of a stock—a higher-risk stock requires a higher equity risk premium to be attractive to investors.

What does a higher equity risk premium mean?

The equity risk premium helps to set portfolio return expectations and determine asset allocation. A higher premium implies that you would invest a greater share of your portfolio into stocks. The capital asset pricing also relates a stock's expected return to the equity premium.

What causes equity risk premium to increase?

The equity risk premium fluctuates with changes in the economy, inflation outlook, interest rates and monetary policy. When economic growth slows and the outlook for the stock market is gloomy, the equity risk premium is likely to increase.

Is a higher market risk premium better?

Equity risk premiums exist because investors demand a premium on the returns for their equity investments versus the returns from low-risk investments or risk-free investments such as Treasuries. In short, if an investor's money is at a greater risk for a loss, a higher premium is likely needed to entice them to buy.

What determines the equity risk premium?

The equity risk premium is calculated as the difference between the estimated real return on stocks and the estimated real return on safe bonds—that is, by subtracting the risk-free return from the expected asset return (the model makes a key assumption that current valuation multiples are roughly correct).