A risk premium is the compensation investors want for taking on uncertainty. Equity investors expect more than the return on safer government paper because share prices can fall sharply. Lenders demand a credit risk premium when a borrower looks less secure. Premiums widen when fear rises and can shrink when confidence is high.
Key takeaways
- Risk premium is the extra expected reward for bearing extra risk.
- It is expected, not guaranteed; actual outcomes can undershoot.
- Credit spreads and equity valuations both embed risk premium ideas.
- When premiums look very thin, future returns may be modest relative to risk.