Every investment decision poses the same question: why take a risk rather than accept a guaranteed return? The answer holds in one idea: you take the risk only if it is paid. That expected "payment" is the equity risk premium. To grasp it is to hold a compass for judging whether stocks are attractive or expensive — and for reading the rare moment when that premium vanishes.
1 The definition
The reward demanded for risk.
The definition
Extra return against uncertainty
The equity risk premium is the extra return an investor demands for holding stocks rather than an investment deemed "risk-free," typically a government bond. A stock can fall, a company can disappoint: to accept that uncertainty, one asks for more than a bond's guaranteed yield. Historically, that surplus has run around 3 to 5 percentage points. It is what justifies, in theory, taking the risk: without a premium, there is no reason to.
2 The measure
Earnings yield versus bond yield.
The simple calculation
The earnings yield minus the rate
The "true" premium is not observable: it depends on future returns, which are unknown. So it is approximated. The most common method subtracts the government bond yield from the stock's "earnings yield" (a company's earnings relative to its price, the inverse of the famous price/earnings ratio). If stocks yield 5% of earnings and the bond 4.5%, the approximate premium is 0.5 points. It is a crude but telling gauge: when it falls toward zero, the stock barely rewards risk relative to government debt.
3 The Fed model
A tempting comparison, but a contested one.
The key nuance
Comparing the real and the nominal
This direct comparison between earnings yield and bond yield has a name: the "Fed model." It is intuitive, but theoretically fragile. The financier Cliff Asness showed its flaw: it compares a real quantity (a company's earnings, which grow with inflation) to a nominal one (a bond's fixed coupon). Above all, earnings rise over time, while the coupon does not: the earnings yield therefore understates the real expected return of stocks. The gauge remains useful as a signal, but it should not be read as a mechanical truth.
4 TINA and TARA
When the bond becomes an alternative again.
The shift
From "no alternative" to "reasonable alternatives"
The risk premium is not fixed: it moves with rates. When bonds yield next to nothing, the equity premium looks wide and the stock imposes itself: this is the "TINA" regime (There Is No Alternative). When rates rise, the bond becomes a rewarding investment again, the equity premium compresses, and one moves to the "TARA" regime (There Are Reasonable Alternatives). Naming this shift is to understand why the same level of stocks can look cheap yesterday and expensive today.
The takeaway
The risk premium is not a prediction but a measure of margin. A wide premium offers a cushion; a zero premium thins it — without saying when, or whether, the wind will turn.
5 Key points
To remember.
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Equity risk premium: the extra return demanded for holding stocks rather than "risk-free" government debt; 3 to 5 points on average.
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The common measure: a stock's earnings yield minus the bond yield — a simple but crude gauge.
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The Fed model is contested (Asness): it compares a real quantity to a nominal one and understates earnings growth.
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TINA → TARA: when rates rise, the bond becomes an alternative again and the equity premium compresses.
This notion illuminates an analysis
First published: July 10, 2026