The equity risk premium is the expected return of equities minus the risk-free rate (typically the 10-year Treasury yield). It's the compensation investors require for taking on equity risk instead of simply holding a government bond. When bond yields rise without equity return expectations rising to match, the ERP compresses — equities become relatively less attractive and capital rotates toward bonds, pressuring stock prices.
The formula
Expected Equity Return−Risk-Free Rate
= Equity Risk Premium
Why it matters
- —It's the relative-value lens connecting the stock market to the bond market — equities don't trade in isolation from what bonds yield.
- —A shrinking ERP is a warning sign that equities are expensive relative to the safe alternative, even if nothing about the businesses themselves has changed.
- —ERP expectations shift with sentiment as much as with rates — fear pushes the required premium up, compressing the price investors are willing to pay.
How to read it
| ERP well above historical average | Equities offer attractive compensation for risk relative to bonds |
| ERP near historical average | Fair relative value between stocks and bonds |
| ERP compressed or negative | Equities offer little premium over bonds — relatively expensive |