What Is Risk Premium?
Risk premium is the extra return investors expect for taking more risk instead of choosing a relatively safe investment.
Suppose a U.S. Treasury offers a 4% annual yield. An investor considering stocks would usually expect a higher return because stock prices can fall and future returns are uncertain. If the investor expects a stock portfolio to return 9%, the difference is 5%.
The calculation can be seen as:
Risk Premium = Expected Return − Risk-Free Rate
The 4% Treasury yield is the starting point, or risk-free benchmark. The additional 5% is the expected compensation for accepting the greater uncertainty of investing in stocks.
Importantly, the 5% is not an additional payment that investors are guaranteed to receive. The stock portfolio could ultimately return more or less than 9%, or even lose money. Risk premium describes the additional return investors expect or require before they are willing to accept more risk.
The same logic can be applied to crypto, although estimating the expected return is much harder. If relatively safe assets already offer attractive yields, investors have a higher hurdle before taking the greater volatility and uncertainty associated with Bitcoin, altcoins, or other crypto investments.
This is why the risk-free rate matters for crypto. As relatively safe returns rise, risky assets generally need to offer sufficiently attractive expected returns to compensate investors for taking the additional risk
Risk premium is the extra return investors expect for taking more risk instead of choosing a relatively safe investment.
Suppose a U.S. Treasury offers a 4% annual yield. An investor considering stocks would usually expect a higher return because stock prices can fall and future returns are uncertain. If the investor expects a stock portfolio to return 9%, the difference is 5%.
The calculation can be seen as:
Risk Premium = Expected Return − Risk-Free Rate
The 4% Treasury yield is the starting point, or risk-free benchmark. The additional 5% is the expected compensation for accepting the greater uncertainty of investing in stocks.
Importantly, the 5% is not an additional payment that investors are guaranteed to receive. The stock portfolio could ultimately return more or less than 9%, or even lose money. Risk premium describes the additional return investors expect or require before they are willing to accept more risk.
The same logic can be applied to crypto, although estimating the expected return is much harder. If relatively safe assets already offer attractive yields, investors have a higher hurdle before taking the greater volatility and uncertainty associated with Bitcoin, altcoins, or other crypto investments.
This is why the risk-free rate matters for crypto. As relatively safe returns rise, risky assets generally need to offer sufficiently attractive expected returns to compensate investors for taking the additional risk