# Equity Premium

Source: https://www.yieldcurve.pro/learn/equity-premium

The **equity premium** (or equity risk premium) is the additional return that stocks are expected to deliver above the risk-free rate. It is the compensation investors demand for bearing the systematic risk of equity ownership — the possibility of permanent capital loss, deep drawdowns, and correlated losses during recessions.

Historical estimates of the realized equity premium over U.S. Treasuries range from roughly **4% to 6%** annually, depending on the measurement period and whether arithmetic or geometric averaging is used. Forward-looking estimates based on valuation models tend to be lower, typically **3% to 5%**.

The equity premium connects directly to the yield curve through several channels:

- **Discount rates**: when Treasury yields rise, the equity premium narrows unless stock expected returns rise proportionally. The 2022 selloff in both stocks and bonds reflected, in part, a repricing of the risk-free rate that compressed equity valuations.
- **[Term premium](https://www.yieldcurve.pro/learn/term-premium) analogy**: just as bond investors demand a term premium for holding duration risk, equity investors demand an equity premium for bearing equity risk. Both are compensation for systematic, non-diversifiable risk.
- **Allocation decisions**: the equity premium relative to the risk-free rate determines the optimal equity weight for any given level of [risk aversion](https://www.yieldcurve.pro/learn/risk-aversion). A shrinking equity premium implies lower optimal equity allocations.

The equity premium is the single most important parameter in long-run [asset allocation](https://www.yieldcurve.pro/learn/asset-allocation). Small changes in the assumed premium compound into large differences in recommended equity weights over a multi-decade horizon.