Equity Risk Premium (ERP)
Definition
The equity risk premium is the extra return investors demand for holding the stock market instead of risk-free government bonds: ERP = expected market return − risk-free rate. It is the price of systematic equity risk and a core input to CAPM: cost of equity = risk-free rate + beta x ERP.
It is estimated from long-run historical excess returns of stocks over bonds, from forward-looking implied models (backing the ERP out of current prices and expected cash flows), or from survey data. Estimates commonly cited in US practice fall roughly in the 4-6% range, but the number varies by source, method, and period — cite a source rather than asserting a single true value.
A higher ERP raises the cost of equity and WACC, lowering DCF values across the board — it is one of the most value-sensitive assumptions in intrinsic valuation.
Why interviewers ask
The ERP appears inside every CAPM answer, and interviewers probe whether you know it is the market return MINUS the risk-free rate, not the market return itself. They may also ask what you would use and why — the strong answer names a method or source (historical vs. implied) and acknowledges the estimate is uncertain.
Related terms
Interviews don't test definitions — they test recall under pressure.
Drill 1,500+ real questions with spaced repetition. Free to start — 10 reps a day on the house.