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Market Risk Premium

Definition

The excess return investors expect from the market portfolio over the risk-free rate.

How It Works

MRP = E(Rm) - Rf. Historically around 5-7% for U.S. equities. It compensates investors for bearing systematic risk.

Example

If E(Rm) = 10% and Rf = 3%, the market risk premium is 7%.

Common Misconceptions

  • It is a fixed number
  • You can measure it precisely (it must be estimated)

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FAQs

Common questions about Market Risk Premium

Use whatever your textbook or professor specifies. Common values are 5-7%.

Different estimation methods (historical average, survey-based, implied from prices) produce different results. Historical lookback periods also matter since US equity markets have returned more in some decades than others.

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