What does the term "market risk premium" refer to?

The term "market risk premium" refers to the additional return expected from risky investments compared to risk-free investments, typically associated with the expected return on the market over the return on a risk-free asset, such as government treasury bills. This concept is fundamental in finance as it reflects the excess return that investors require for taking on the additional risk associated with investing in the stock market or other risky assets.

The market risk premium is integral to various financial models, including the Capital Asset Pricing Model (CAPM), which uses it to help determine the expected return on an investment based on its systematic risk. Essentially, the market risk premium quantifies how much more return an investor can anticipate from risky investments compared to investing in a safe asset, thus compensating them for the uncertainty and potential volatility involved in these investments.

This understanding supports investment decisions and portfolio management, allowing investors to assess whether the potential returns of a risky investment justify the associated risks.