The difference between the determined income and the risk-taking income is the risk premium. It is the compensation for investors' own risk requirements.
Risk premium means that investors demand higher returns to offset greater risks. The "junk" bonds issued by companies with financial turmoil usually pay higher interest than the particularly safe debt interest, because investors are worried that the company will not be able to pay the promised amount.
Risk premium is a core concept of financial economics, which is of great theoretical significance for asset selection decision, capital cost and EVA estimation, especially for China's social security fund to enter the stock market on a large scale.
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Two different meanings of "risk premium" It should be noted that the word "risk premium" has two different meanings:
One is ex post or realized risk premium, which is the difference between the actual market rate of return (replaced by index rate of return) and the risk-free interest rate (usually replaced by national debt rate of return) observed through historical data;
The second is the ex ante or expected risk premium, which is a forward-looking premium, that is, the expected future.
Risk premium or conditional risk premium based on the current economic situation. These two risk premiums are different. For example, in the Japanese stock market at the end of 1989, due to the long-term prosperity, the stock price was relatively high relative to its intrinsic value, and the P/E ratio exceeded 60 times.
Obviously, the cost of equity at this time is very low, that is, the risk premium beforehand is very low, while the risk premium afterwards or realized is very high (close to 10%). On the contrary, after a stock market crash, the risk premium afterwards is very low, while the risk premium beforehand may be high. This is due to the mean regression of stock returns.
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