To calculate the equity risk premium, subtract the risk-free rate from the expected return on the stock market. The risk-free rate is almost always the current yield on the 10-year U.S. Treasury bond; the expected market return can come from either historical averages or a forward-looking estimate built from today’s dividend yield and expected earnings growth. As of March 2026, the 10-year Treasury yield sat near 4.27%, and forward-looking forecasts put the expected premium at roughly 2% for the coming decade.
Inputs You Need Before You Start
Every version of the calculation needs two numbers, and a third if you want the premium for one specific stock.
The risk-free rate comes from the 10-year Treasury yield, published on the Daily Treasury Par Yield Curve Rates page and available historically through the FRED database at the Federal Reserve Bank of St. Louis.1Federal Reserve Bank of St. Louis. Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity
The expected market return comes from one of two places. Historically, you use the average annual return of a broad index like the S&P 500, available through FRED and standard financial data providers.2Federal Reserve Bank of St. Louis. Federal Reserve Economic Data For a forward-looking estimate, you combine the index’s current dividend yield with an analyst consensus for long-term earnings growth.
If you want the premium for a single stock rather than the whole market, you also need its Beta, which measures how much the stock moves relative to the market. Beta is reported on most financial portals.
The Historical Method
This is the simpler of the two calculations. Take the long-run average annual market return, subtract the current risk-free rate, and the difference is your historical equity risk premium.
ERP = Average Market Return − Risk-Free Rate
Using a commonly cited long-run average of about 10% for U.S. stocks and a 10-year Treasury yield of roughly 4.3%, the historical premium works out to about 5.7%. Over the very long run from 1802 to 2002, the premium of U.S. stocks over Treasury bills has averaged around 5.4%.3Wharton School of Finance. The Historical Market Risk Premium – The Very Long Run
The appeal is a large data set and simple arithmetic. The trap is that your answer depends heavily on two choices most people don’t realize they’re making: the time period and the averaging method.
Arithmetic Versus Geometric Averages
This is where do-it-yourself calculations quietly go wrong. An arithmetic average adds each year’s return and divides by the number of years. A geometric average compounds the returns, reflecting what a buy-and-hold investor actually earned. The geometric figure is always lower, and the gap widens with volatility.
For a one-year expected return, the arithmetic average is standard. For long-term valuation work, discounting cash flows over a decade or more, the geometric average is more appropriate because stock returns tend to be negatively correlated over time, meaning the arithmetic average systematically overstates what a long-horizon investor should expect.4NYU Stern. Chapter 4 Derivations – Discussion Issues and Derivations In corporate finance and business valuation the case for geometric averaging is strong.5NYU Stern School of Business. Equity Risk Premiums – Determinants, Estimation, and Implications
The practical spread is real. An arithmetic average might give you an ERP of 7–8% while the geometric average over the same period lands around 5–6%. If you use the arithmetic figure for a long-horizon valuation, you’re discounting future cash flows at too low a rate and probably overvaluing the asset.
A Note on Survivorship Bias
Historical U.S. stock returns look strong partly because we’re studying a market that survived and thrived. Databases tend to include companies that exist today and drop ones that went bankrupt years ago, which inflates historical averages. The same bias applies at the country level: the U.S. market’s twentieth-century performance was exceptional compared to most other countries.6IESE Business School. Equity Premium – Historical, Expected, Required and Implied Some analysts subtract 1.5 to 2 percentage points from the raw historical average to compensate. Whether you apply that haircut or not, treat the historical U.S. ERP as the ceiling of what to expect, not the floor.
The Forward-Looking Method
Rather than looking backward, this approach uses current prices to infer what return the market is pricing in. It rearranges the Gordon Growth Model, also called the dividend discount model, to extract the market’s implied expected return.
ERP = (Dividend Yield + Expected Growth Rate) − Risk-Free Rate
Say the S&P 500 has a dividend yield of 1.2% and analysts expect long-term earnings growth of 5%. The implied expected market return is 6.2%. Subtract a 4.3% Treasury yield and the implied forward-looking premium is about 1.9%. That matches recent institutional forecasts: Schwab’s 2026 long-term capital market expectations put the expected ERP at around 2% for the 2026–2035 period, reflecting elevated stock valuations and higher bond yields.7Charles Schwab. Schwab’s 2026 Long-Term Capital Market Expectations
The advantage is that this method incorporates current conditions instead of assuming the future will look like the twentieth century. When valuations are high and dividend yields are low, the implied premium drops, which matches intuition: a market trading at lofty multiples offers less compensation for risk than a beaten-down one.
Where the Gordon Model Breaks Down
The formula’s simplicity hides some aggressive assumptions. It requires dividends to grow at a constant rate forever, which no real market delivers. It also understates payouts when companies return cash through buybacks rather than dividends, a common pattern among U.S. tech firms. In that environment, using the plain dividend yield produces an implied premium that’s too low.5NYU Stern School of Business. Equity Risk Premiums – Determinants, Estimation, and Implications
Some analysts fix this by using total shareholder yield (dividends plus buybacks) or by building multi-stage models that allow faster near-term growth before settling into a stable long-term rate. Both add complexity and both produce more realistic estimates.
Which Method to Use
Neither method is definitively correct, but most valuation professionals today lean toward the forward-looking estimate, or at least cross-check the historical figure against the implied premium. Assuming twenty-first century markets will reward risk at the same rate as the twentieth is a large leap; as one researcher put it, it is not clear why nineteenth-century capital market data should be useful for estimating today’s expected returns.6IESE Business School. Equity Premium – Historical, Expected, Required and Implied
A practical approach is to run both. If the historical premium says 5–6% and the implied premium says 2%, the gap tells you something: the market is priced for lower future returns than history delivered. Using the historical figure in that environment would lead you to overestimate future returns and overpay for assets.
Calculating the Premium for a Single Stock
The market-wide ERP tells you the extra return expected from equities as a group. For one specific stock, you use the Capital Asset Pricing Model (CAPM), which scales the market premium by the stock’s Beta.
Expected Return = Risk-Free Rate + (Beta × Market ERP)
If the risk-free rate is 4.3%, the market ERP is 5%, and a stock’s Beta is 1.2, the expected return is 4.3% + (1.2 × 5%) = 10.3%. The stock’s specific risk premium is the portion above the risk-free rate, or 6%. A stock with a Beta of 0.8 would have a risk premium of only 4%, reflecting its lower sensitivity to market swings. A Beta above 1.0 means the stock is more volatile than the market and demands a larger premium; below 1.0 means less volatility and a smaller premium; exactly 1.0 gives you the market premium itself.
Adjusting Beta for Leverage
The Beta you find on financial portals reflects the company’s current capital structure, including its debt. That’s the levered Beta. A company that takes on more debt becomes riskier to equity holders, pushing its Beta higher even if the underlying business risk hasn’t changed.
When you compare companies with different debt levels, or apply an industry Beta to a company with an unusual capital structure, strip out the debt effect first to get the unlevered Beta, then re-lever for your target company:
Levered Beta = Unlevered Beta × (1 + (1 − Tax Rate) × (Debt / Equity))
An unlevered Beta of 0.95 for a company with a 25% tax rate and a debt-to-equity ratio of 0.20 produces a levered Beta of 0.95 × (1 + 0.75 × 0.20) = 1.09. The higher Beta means a higher required return, reflecting the financial risk the debt creates for shareholders.8NYU Stern. Relative Risk Measures
Adding a Size Premium
Basic CAPM assumes Beta captures all relevant risk, but decades of market data show small-cap stocks consistently outperform what their Betas predict. Many analysts add a size premium for smaller companies:
Expected Return = Risk-Free Rate + (Beta × Market ERP) + Size Premium
The size premium grows as market capitalization shrinks. For very small companies (under roughly $150 million in market value), the adjustment can run several percentage points, and some valuation professionals report size premiums exceeding 6% for the smallest publicly traded firms.
Adjusting for Inflation
An ERP calculated from nominal returns is a nominal figure. If you need to compare it against a real, inflation-adjusted required return, deflate it:
Real ERP ≈ Nominal ERP − Expected Inflation Rate
A nominal ERP of 5% with expected inflation of 2.5% produces a real ERP of roughly 2.5%. For more precision, use the Fisher equation: (1 + Nominal Rate) / (1 + Inflation Rate) − 1. The difference is small at low rates but compounds over long horizons.
One way to gauge expected inflation is the breakeven inflation rate, the difference between the yield on a standard Treasury and a Treasury Inflation-Protected Security (TIPS) of the same maturity. Both yields appear on the Treasury’s daily rate page.9U.S. Treasury Fiscal Data. Average Interest Rates on U.S. Treasury Securities
Taxes add another layer the standard formula doesn’t touch. Capital gains taxes reduce after-tax returns from equities differently than the ordinary-income tax treatment that often applies to Treasuries, and the net effect on your after-tax premium depends on your tax bracket, holding period, and whether you’re realizing gains annually or deferring them. Investors in high brackets should recognize their personal after-tax ERP is meaningfully lower than the pretax figure.
Reading Your Answer
A historical ERP of 5–6% and a forward-looking ERP near 2% can both be correct because they answer different questions. The historical figure tells you what the market delivered. The implied figure tells you what current prices suggest about the future. When they diverge widely, valuations have shifted: a low implied ERP signals that stocks are expensive relative to bonds, not that investors have stopped caring about risk.
The arithmetic itself is simple. The judgment is in choosing your inputs, matching your averaging method to your time horizon, and knowing what each answer actually means. Getting the number wrong by even a percentage point compounds into serious valuation errors over a multi-year forecast.