Measuring performance
Equity risk premium
Also called ERP
The extra return investors expect from shares over risk-free government debt, for accepting the risk.
How it works
The premium is the compensation for equity’s volatility and its position at the back of the queue in a bankruptcy. Historically it has been substantial, though the realised figure varies widely by period and country.
Expected and realised premiums are different things. The realised premium is what happened; the expected one is a forecast, and forecasts of it vary enormously between reasonable people.
Where it misleads people
Extrapolating the last few decades of one country’s equity premium assumes that country’s exceptional run repeats. Survivorship bias in long-run market data makes this trap easy to fall into.
Related terms
- Risk-free rateThe return available with essentially no risk of default, used as the baseline for every other return.
- Capital asset pricing modelA model saying an asset’s expected return depends on the risk-free rate plus its market risk.
- Survivorship biasThe distortion caused by measuring only the things that made it, and ignoring the ones that failed.
- Systematic riskRisk that affects the whole market and cannot be removed by holding more things.
Mentioned in
More in Measuring performance
- Information ratio
- Contribution to return
- Look-ahead bias
- Calmar ratio
- Mark to market
- CAGR
- Money-weighted return
- Benchmark
All 29 Measuring performance terms · The full glossary, 433 terms
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.