Market risk premium: Required, historical and expected

Pablo Fernandez

No D/574, IESE Research Papers from IESE Business School

Abstract: The market risk premium is one of the most important but elusive parameters in finance. It is also called equity premium, market premium and risk premium. The term 'market risk premium' is difficult to understand because it is used to designate three different concepts: 1) Required market risk premium, which is the incremental return of a diversified portfolio (the market) over the risk-free rate (return of treasury bonds) required by an investor. It is needed for calculating the required return to equity (cost of equity). 2) Historical market risk premium, which is the historical differential return of the stock market over treasury bonds. 3) Expected market risk premium, which is the expected differential return of the stock market over treasury bonds. Many authors and finance practitioners assume that the expected market risk premium is equal to the historical market risk premium and to the required market risk premium. The CAPM assumes that the required market risk premium is equal to the expected market risk premium. However, the three concepts are different. The historical market risk premium is equal for all investors, but the required and the expected market risk premium are different for different investors. We also claim that there is no required market risk premium for the market as a whole: different investors use different required market risk premiums.

Keywords: required market risk premium; historical market risk premium; expected market risk premium; risk premium; equity premium; market premium (search for similar items in EconPapers)
JEL-codes: G12 G31 M21 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2004-10-17
New Economics Papers: this item is included in nep-acc, nep-fin and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.iese.edu/research/pdfs/DI-0574-E.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ebg:iesewp:d-0574

Access Statistics for this paper

More papers in IESE Research Papers from IESE Business School IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN. Contact information at EDIRC.
Bibliographic data for series maintained by Noelia Romero ().