Risk premium

The difference between a rate of return and the risk free rate of return is a risk premium. Risk premiums may be calculated for a particular security, a class of securities, or a market.

Market risk premiums in general are important, as they are used by securities valuation models such as CAPM. The equity risk premium is particularly important.

The risk premium of a share is usually considered implicitly rather than explicitly. The term (β × (rm - rf)) used in the CAPM is the equity risk premium of the security being valued. Similarly, it usually easier to think in terms of sector beta compared to the market. Sector and security risk premiums are more likely to be explicitly calculated for debt instruments — see yield spread and z-spread.

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