The term premium is the compensation investors require for bearing the risks associated with holding a long-term bond instead of repeatedly rolling over short-term securities. It is not directly observable but can be estimated using term structure models.
A long-term yield can be decomposed into two parts:
The Adrian, Crump, and Moench (ACM) model, published by the Federal Reserve Bank of New York, is the most widely used term premium estimate. It decomposes Treasury yields into expectations and risk premium components using a no-arbitrage affine term structure model.
Term premiums can be negative, as they were for much of the 2010s during quantitative easing, when central bank purchases compressed the compensation for holding duration risk. Positive term premiums tend to emerge when inflation uncertainty rises, fiscal deficits expand, or the Fed is reducing its balance sheet.
Changes in the term premium drive long-term yields independently of expectations about short-term rates. This distinction matters for interpreting yield curve movements: a rising 10-year yield could reflect either higher expected policy rates or a rising term premium, with very different economic implications.