Risk premium and market risk premium are related concepts in finance, but they measure different things. A risk premium is the extra return an investor demands for taking on any risk above a risk-free rate—it compensates for uncertainty. The market risk premium specifically refers to the excess return expected from investing in the overall stock market compared to risk-free investments like government bonds.
Think of it this way: every investment with risk carries a risk premium. A corporate bond, a single stock, or a real estate investment all have their own individual risk premiums based on their specific risks. The market risk premium is one specific type—it's the premium for taking on systematic risk by investing in the broader market rather than holding only safe assets.
The market risk premium is calculated as the expected return of the market portfolio minus the risk-free rate. This figure is central to the Capital Asset Pricing Model (CAPM), which estimates expected returns for individual securities. For example, if the stock market is expected to return 10% annually and government bonds return 2%, the market risk premium is 8%.
An individual stock's total risk premium includes the market risk premium multiplied by its beta (a measure of how much it moves with the market) plus any additional premium for company-specific or unsystematic risks. So while all market investments benefit from the market risk premium as a baseline, individual securities may demand additional compensation for risks unique to them. Understanding this distinction helps investors recognize that diversification can eliminate some premiums by reducing unsystematic risk, but the market risk premium remains unavoidable when investing in equities.