ERP
Equity Risk Premium
Short definition
The equity risk premium is the extra return expected on the equity market above the risk-free rate. CAPM multiplies it by β. Historical averages, implied premia and surveys disagree; there is no single “true ERP”.
Detailed explanation
Currency must match Rf. A long historical premium may not match today’s rate regime. Implied ERP is backed out of price and expected earnings.
A local ERP versus a global ERP+CRP are alternative skeletons; do not add both.
Why it matters for the CFO
1 point of ERP moves Ke and WACC by about 1 point when β≈1. The valuation committee should write which ERP source it chose.
How it is calculated
ERP = E[r_m] − Rf
Variables in the formula
- ERP: Equity market minus risk-free
How to read it
In a high-Rf regime, stacking a historic ERP can overstate Ke; an implied premium may be more consistent.
Numerical example
E[r_m] 28%, Rf 22% → ERP = 6 percentage points.
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Definitions are educational. They are not investment, credit or tax advice.