Equity Risk Premium

The equity risk premium (ERP) is the minimum return investors should demand to compensate them for the risk exposure of an equity portfolio over and above risk-free real bond yields. In essence, investors use the ERP as a proxy for how much the stock market (i.e. a stock index) is expected to outperform inflation-linked government bonds. The ERP is widely used to determine asset pricing, cost of capital and savings choices. It is seen by some as a leading indicator of economic performance, since research shows that a high ERP typically precedes higher economic growth (and higher inflation). By the same token, a high ERP may be the result of low risk-free rates rather than high expected equity returns based on future earnings or dividends.