The risk premium is the return in excess of the risk-free rate of return that investors require to compensate them for the additional risk associated with a particular investment. It reflects the general principle that higher risk should be associated with the potential for higher returns. In finance, the concept is often applied in different contexts: 1. **Equity Risk Premium**: This is the additional return expected from investing in the stock market over a risk-free investment, such as government bonds.
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In expected utility theory, the risk premium is the difference between expected wealth and its certainty equivalent: U(CE(W))=EU(W). For increasing concave utility functions it is nonnegative by the Jensen inequality. In financial asset pricing, risk premium also refers to expected return above a specified risk-free benchmark; the benchmark and whether the premium is monetary or proportional must therefore be stated.