Market risk premium is arguably the most important concept in investment planning finance. Market risk premium is extremely important to calculate expected return as well as to quantify risk-adjusted performance in simple portfolios and sophisticated portfolios.From determining the cost of equity to using the CAPM model, market risk premium assists investors and analysts to comprehend the risk versus expected return trade-off. In this article, let's discuss what is market risk premium formula, how to calculate market risk premium, the precise formula, and how it varies by markets.What is the Market Risk Premium?Market risk premium is the extra return that investors require from holding a risky market portfolio in place of a risk-free asset based on the formula for the equity market risk premium formula. It is simply the return that investors require to bear the greater risk of holding the market in place of less risky assets like government debt.This volatility is the essence of investment decision-making to arrive at a conclusion whether or not risk investment in stocks or other risky investments is preferable to risk-free investments. The risk-free rate of return generally seems to be the return on government securities such as the 10-year U.S. Treasury note.For the market risk premium formula, market return of 9% and 10-year Treasury return at 4%, market risk premium would be 5%. It is one of the main inputs, which are input into models such as CAPM (Capital Asset Pricing Model), which are used in the grand scale of expected return of an asset or a stock depending on beta and market.Market Risk Premium in Different MarketsMarket risk premium is never a fixed amount --- because it depends on country, circumstance, and sentiment and many more components that make it valuable.United StatesIn the United States, the S&P 500 formula for market risk premium has traditionally been regarded as a standard. It has fluctuated from 4% to 6% over time, depending on what is happening in the market. Nowadays, as of 2024--2025, different financial experts, including NYU professor Aswath Damodaran, put the implied equity risk premium in the United States at approximately 5.0%.Emerging MarketsThe emerging formula for market risk premium is extremely high compared to developed economies. The reason for this is that these markets experience greater macroeconomic volatility, exchange rate fluctuations, political risk, and weak legal frameworks, making the overall risk profile higher for investors.For example, Brazil, India, South Africa, and Turkey could have market risk premiums of between 6% and 9%, varying according to the business cycle and investor sentiment. The premiums are both a representation of the world market's systematic risks as well as specific country idiosyncratic risks of inflation, corruption, or capital controls.To account for this extra risk, analysts even use a country risk premium (CRP) and attach the same as a spread on an underlying equity risk premium in emerging markets. This method was introduced first by finance analysts like Aswath Damodaran that uses a measure such as sovereign credit rating, Credit Default Swap (CDS) spread, and domestic bond yield as drivers to measure excess risk while undertaking business in such markets.To multinationals and investors targeting frontier markets as the sources of their investment, an explanation and factoring in for a greater market risk premium in order to adequately value, especially in estimating the return on fresh purchases or investment in low-credit-rated nations or nations with a weak institution. Europe and AsiaIn Western Europe, market risk premiums are relatively stable at around 4% to 5%. These are mature, low-risk, developed economies in the form of Germany, France, the Netherlands, and Switzerland. Risk premium in the longer term tends to be lower than in the United States with lower expectations of growth and lower market volatility.But areas in Eastern and Southern Europe can be assumed to have a higher risk premium, especially for nations newly experiencing political unrest or riskier economies, i.e., Hungary, Poland, or Greece. Regional adjustments are applied by investors to incorporate higher default probabilities and exchange rate risks.The market risk premium is fairly variegated in Asia:In one of the region's most developed economies, Japan, the market risk premium is typically low, 3% to 4%, due to past monetary stability and highly refined financial markets. But extended economic stagnation and demographic pressures can put a strain on anticipated returns.South Korea and Singapore also offer moderate market risk premiums, in line with their developed economy status, stable financial institutions, and good governance.Meanwhile, Indonesia, China, Vietnam, and the Philippines are more expensive in terms of premiums - 5% to 7% - due to political risks, regulatory risks, and the magnitudes of political risks.Table of Market Risk Premium in Different Markets| Country | Adj. Default Spread| Equity Risk Premium | Country Risk Premium | Corporate Tax Rate | Moody's rating | Sovereign CDS Spread || ------------------------- | ------------------------- | ------------------- | -------------------- | ------------------ | -------------- | -------------------- || Abu Dhabi | 0.54% | 5.32% | 0.72% | 15.00% | Aa2 | 0.75% || Albania | 4.90% | 11.18% | 6.58% | 15.00% | B1 | NA || Algeria | 4.90% | 11.18% | 6.58% | 26.00% | NR | 1.70% || Andorra (Principality of) | 2.07% | 7.38% | 2.78% | 18.98% | Baa2 | NA || United States | 0.00% | 4.60% | 0.00% | 25.00% | Aaa | 0.58% || United Kingdom | 0.65% | 5.48% | 0.88% | 25.00% | Aa3 | 0.51% || Austria | 0.44% | 5.18% | 0.58% | 24.00% | Aa1 | 0.27% || Australia | 0.00% | 4.60% | 0.00% | 30.00% | Aaa | 0.26% || Aruba | 2.07% | 7.38% | 2.78% | 25.00% | Baa2 | NA || Armenia | 3.92% | 9.86% | 5.26% | 18.00% | Ba3 | NA || Argentina | 13.07% | 22.15% | 17.55% | 35.00% | Ca | 46.19% || Antigua & Barbuda | 10.54% | 18.75% | 18.75% | 27.25% | NR | NA || Anguilla | 10.54% | 18.75% | 18.75% | 27.25% | NR | NA || Angola | 7.08% | 14.11% | 9.51% | 25.00% | B3 | 7.82% |More broadly, the European and Asian market risk premium is very different depending on a country's economic maturity, political stability, and integration with global finance. Disaggregation has to be applied by investors in evaluating the risk in these markets on the basis of local macro fundamentals as well as international economic forces.What Is the Difference Between Equity Risk Premium and Market Risk Premium?While the two terms are often used interchangeably in most situations, equity risk premium and market risk premium do have technical differences.Market risk premium refers to the return that is anticipated on the market in excess of the risk-free rate. It could include all investable asset classes --- and not just equities.The term equity risk premium (ERP), however, is reserved to describe directly the marginal or excess return available from investing in the stock market relative to the risk-free rate.In most practical applications, particularly if you are writing on the S&P 500, the formula for market risk premium can be assumed as the equity risk premium because equities make up the bulk in most of the portfolios. However, in a longer-term financial model, the equity market risk premium formula will also encompass commodities, property, or firm bonds.How to Calculate Market Risk PremiumYou need two main inputs in order to determine how to calculate the market risk premium:Expected Market Return (Rm) -- Typically a historical mean of a wide market index like the S&P 500.Risk-Free Rate (Rf) -- Usually assumed to be the current yield of government bonds (e.g., U.S. 10-year Treasury bond).Here is how to calculate market risk premium:Market Risk Premium = Expected Market Return - Risk-Free RateExample:If the S&P 500's expected return is 8% and the 10-year Treasury yield is 3%, then:MRP = 8% -- 3% = 5%This 5% is the additional return an investor expects to earn from assuming the higher risk of the market instead of investing in a sure-thing bond. Market Risk Premium FormulaAside from the simple subtraction approach, the market risk premium formula is at the heart of the CAPM (Capital Asset Pricing Model):CAPM Formula:Expected Return (Re) = Rf + β × (Rm -- Rf)Where:Re = Expected return on the investmentRf = Risk-free rateβ (Beta) = Volatility of the investment compared to the marketRm -- Rf = Market risk premiumThis is occasionally called the beta market risk premium equation because it factors in a stock's sensitivity to market motion. A high-beta stock will have a higher expected return (and risk), while a low-beta stock will have a lower expected return.The market risk premium formula of equity is generally expressed by the CAPM model. For example, if a stock has a beta of 1.2, and the market risk premium is 5%, and the 4% risk-free rate:Expected Return = 4% + 1.2 × (5%) = 10%This is applied in valuation models and financial decisions.