Risk premium

A risk premium is the price of uncertainty, written as return. The best known is the equity risk premium, the return expected on stocks above the return on something treated as risk-free. In the United States, short-dated Treasury bills are the usual stand-in for that risk-free rate. Bonds carry their own versions, including a credit spread for the chance of default and a term premium for tying money up for longer.

It is the piece that turns a risk measure into an expected return. Under the capital asset pricing model, an asset's expected return is the risk-free rate plus its beta multiplied by the market risk premium, so what an asset earns scales with its systematic risk rather than with its total variability. The same number sits inside every discounted valuation: raise the premium, the discount rate rises with it, and what a future cash flow is worth today falls. The net present value calculator shows how sharply that bites on long-dated flows.

The mistake is hearing premium and thinking payment. It is an expectation, not a promise, and the reason it exists at all is that the outcome is uncertain. An investor can hold the risk for a decade and collect a realised premium of nothing, or of less than nothing. Estimates also vary widely with the country, the period and the method behind them, so any single historical average is one estimate carrying wide error bars rather than a constant to plug in.