To calculate the market risk premium, subtract the risk-free rate from the expected return on a broad stock market index. That is the whole formula. The difficulty is not the arithmetic; it is choosing inputs that match each other and reflect defensible assumptions. Get the inputs right and a U.S. equity premium usually lands somewhere between 4% and 7%, depending on the method and time window you use.
The Formula
Market Risk Premium = Expected Market Return − Risk-Free Rate
If you expect the stock market to return 9% per year and the current yield on a long-term Treasury is 4.1%, the market risk premium is 4.9%. That figure represents the extra return investors demand for holding stocks instead of a virtually default-free government bond. Small shifts in either input move the result meaningfully, so most of the work sits in selecting them.
Step 1: Pick a Risk-Free Rate
In practice, “risk-free” means a U.S. Treasury security, because the federal government has never defaulted on its debt. The Treasury publishes daily yields for maturities from one month to 30 years, drawn from closing bid prices on recently auctioned securities.1U.S. Department of the Treasury. Daily Treasury Rates The Federal Reserve Bank of St. Louis tracks the same rates in its FRED database, which showed the 10-year Treasury yielding approximately 4.13% in early March 2026.2Federal Reserve Bank of St. Louis. Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity
Which maturity you pick matters. The professional standard is to match the Treasury’s maturity to your investment horizon. Valuing a company you plan to hold for 10 years? Use the 10-year yield. Valuing a long-lived asset like a business or pension obligation? The 20-year or 30-year yield fits better. Pairing a 3-month T-bill rate with a 10-year expected stock return creates an apples-to-oranges comparison that inflates the premium.
During periods of unusual interest rate volatility, some analysts use a “normalized” risk-free rate instead of the current spot yield, on the theory that today’s yield may be temporarily distorted. Valuation firm Kroll publishes normalized rates alongside spot yields for this reason, switching between them depending on which is higher.3Kroll. Recommended U.S. Equity Risk Premium and Corresponding Risk-Free Rates If you normalize, write down why, because reviewers will ask.
Step 2: Estimate the Expected Market Return
There are two working methods. Either you look at what stocks have returned historically and project that forward, or you back out what return the current market price implies. Both are legitimate; they answer slightly different questions.
The Historical Method
Over the past 150 years, the S&P 500 has delivered an annualized return of roughly 9.5% with dividends reinvested, or about 7% after inflation. Those figures smooth across world wars, depressions, financial crises, and long bull markets. The working assumption is that the future will, on average, resemble the past.
Your choice of time window changes the answer. A 20-year lookback starting in 2009 captures a historic bull run and produces a higher average than a 20-year window starting in 2000, which includes two brutal bear markets. Most practitioners use at least 50 years to dilute any single era, and some stretch to a full century. Whichever you pick, document it. A different analyst using a different window will get a different premium and be able to defend it just as well.
How you average annual returns also matters. The arithmetic mean adds each year’s return and divides by the number of years. The geometric mean compounds them, which always produces a lower figure because it captures the drag volatility imposes on cumulative wealth. If a stock gains 50% one year and loses 50% the next, the arithmetic average is 0%, but $100 becomes $150 becomes $75, a real loss. The geometric mean reflects that; the arithmetic mean does not. Long-term valuation work usually leans on the geometric mean, but you will see both.
The Implied Method
Instead of looking backward, the implied approach asks what return the market is pricing in right now, given today’s prices and expected cash flows. It builds on the Gordon Growth Model:
Expected Return = (Dividend ÷ Price) + Growth Rate
Applied to the S&P 500, take the index’s current dividend yield and add an estimate of long-term earnings growth. The S&P 500’s dividend yield sat near 1.2% in early 2026. Pair that with a long-term earnings growth estimate of 5% to 6% and the implied market return falls in the 6% to 7% range. Subtract the risk-free rate and you have an implied market risk premium.
Aswath Damodaran of NYU, whose equity risk premium estimates are the most widely cited in the field, calculated a mature market equity risk premium of 4.23% at the start of 2026 using a version of this method.4Aswath Damodaran. Data Update 4 for 2026 – A Risk Journey Around the World His model uses forward earnings estimates and buyback-adjusted cash flows rather than dividends alone, which suits an index where many companies return cash through share repurchases.
The implied approach is only as sound as the growth rate you feed it. As one academic study put it, “there are several pairs of premium and growth that satisfy current prices,” so no single implied number is definitive.5IESE Business School-University of Navarra. Equity Premium – Historical, Expected, Required and Implied Investors expecting higher growth will infer a higher premium, and expectations are unobservable.
A Worked Calculation and Sanity Check
Say you are valuing a 10-year cash flow stream. You take the 10-year Treasury yield at 4.1% as your risk-free rate. For the expected market return, you use a long-horizon historical average of 9.1%. Your market risk premium is 5.0%.
Then check the number against the range credible estimates produce:
- Historical, long window, arithmetic mean: roughly 5% to 7%.
- Historical, long window, geometric mean: roughly 4% to 6%.
- Implied approaches based on current prices: roughly 4% to 5.5%.
- Surveys of institutional investors and CFOs: similar range.
A result well outside these bands usually signals a problem with the inputs. Above 8% often means the expected market return is too high, the risk-free rate is too low, or the historical window is too short and too recent. Below 3% often means an unusually high Treasury yield or an overly pessimistic return estimate.
One terminology note. “Market risk premium” and “equity risk premium” are often used interchangeably. Technically the equity risk premium refers specifically to stocks, while the market risk premium can refer to any risky asset class relative to the risk-free rate. For U.S. equity valuation the distinction rarely matters.
Feeding the Premium Into CAPM
The market risk premium rarely stands alone. Its main use is as an input to the Capital Asset Pricing Model, which estimates the required return on a specific investment:
Required Return = Risk-Free Rate + Beta × Market Risk Premium
Beta measures how much a specific stock moves relative to the broad market. A beta of 1.0 means the stock’s systematic risk matches the market. Above 1.0 signals more volatility than the market; below 1.0 signals less.6NYU Stern School of Business. Estimating Risk Parameters Multiplying beta by the market risk premium tailors the generic premium to the risk of the asset you are valuing.
With a 4.1% risk-free rate, a 5% market risk premium, and a stock with beta 1.3, the required return is 4.1% + (1.3 × 5%) = 10.6%. That figure becomes the discount rate in a DCF model or the hurdle rate for a capital budgeting decision. A utility stock with beta 0.6 would need to clear only 7.1%; a volatile tech company at beta 1.8 would need 13.1%.
For investments outside the United States, the standard practice starts with a mature market premium and adds a country risk premium based on that nation’s default spread, sometimes scaled by the ratio of equity market volatility to bond market volatility.7NYU Stern School of Business. Country Default Spreads and Risk Premiums For a company operating in Brazil or India, this can add several percentage points to the discount rate.
Common Input Mistakes
The formula’s simplicity is deceptive. Most errors happen in the inputs, not the subtraction.
- Mismatched horizons. A 3-month T-bill paired with a long-term expected stock return inflates the premium. Match the Treasury maturity to the duration of the cash flows you are discounting.
- Cherry-picked time periods. Starting a historical window right after a crash produces a high average return; starting right before one produces a low average. Use a period long enough that no single event dominates, and be transparent about which years you included.
- Mixing real and nominal figures. If your expected market return is inflation-adjusted but your Treasury yield is nominal, you will understate the premium. Both inputs must sit on the same basis.
- Ignoring dividends. Some S&P 500 return series reflect price appreciation only. Excluding reinvested dividends understates total return by roughly two percentage points per year over the long run, which flows straight into a lower premium.
- Overstating precision. Any estimate carries meaningful uncertainty. Reporting 5.27% as if the second decimal means something oversells the inputs. Rounding to the nearest quarter-point and citing a range of reasonable estimates is more honest and holds up better under scrutiny.
When the Number Will Be Reviewed
If your calculation feeds into an estate tax valuation, a Section 409A determination for private-company stock options, fair value reporting under GAAP, or SEC disclosures for a registered investment company, the assumptions behind your premium are fair game for examiners, auditors, and litigants. The IRS requires executors filing federal estate tax returns to attach appraisals and explain how values were determined.8Internal Revenue Service. Instructions for Form 706 Section 409A regulations require private-company option valuations to use a “reasonable application of a reasonable valuation method,” and examiners look closely at the discount rate inputs when a resulting valuation appears low.9Internal Revenue Service. Final Regulations Under Section 409A Relating to Nonqualified Deferred Compensation Plans GAAP fair value measurement requires consistency and comparability in how values are determined,10Financial Accounting Standards Board (FASB). Summary of Statement No. 157 and registered investment companies must disclose their valuation procedures.11U.S. Securities and Exchange Commission. Valuation of Portfolio Securities and Other Assets Held by Registered Investment Companies Aggressive valuation assumptions also expose filers to accuracy-related penalties under 26 USC 6662.12Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
The practical takeaway is not that any particular premium is “correct” but that yours needs to be reproducible. Pick a methodology, write down which risk-free rate maturity you used, which historical window or which growth assumption fed the expected market return, and why. Then apply the same approach across related valuations. Reviewers care at least as much about whether the process was reasonable as whether the final figure was exactly right.