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risk-premium

Page history last edited by PBworks 15 years, 9 months ago

page director: Brian D.Butler

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Risk Premium
1. How to calculate?:

see rise in risk aversion

Risk Premium

the extra amount of return that you should get for taking the extra amount of risk

note that in stockmarket investing: risk & return are linear...the more risk you take, the more your potential returns. In theory, without taking additional risk, you CAN NOT get additional returns. Who challenges this theory are those that believe in "alpha", or behavioral finance (and do not believe that markets are efficient).

How to calculate?:

Is found by comparing the interest rate of an asset and the "risk-free" rate of T-bills.

For example, if T-Bills are trading at 5%, and an asset is trading at 15%, then the "risk premium" is 10%

Note: US Treasury bills have a historic annual return arithmetic mean of 3.8% (from 1920's - 2000's). The arithmetic mean of the S&P is approx. 12.2%, so the historical "risk-premium" of large company stocks is 8.4%. For small company stocks its around 13%, for long term corporate bonds its 2.4%, and for long term government bonds its 2%. To find the real rate of returns (after inflation) you need to subtract the average inflation for that period (which was approx. 3.1%)

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