Risk premium refers to the additional return or compensation investors expect to receive for taking on a higher level of risk compared to a relatively safer investment. It represents the excess return demanded by investors to hold a risky asset over a risk-free asset, such as government bonds.
The concept recognizes that greater uncertainty and volatility associated with an investment increases the likelihood of potential losses. Therefore, to incentivize individuals to bear the additional risk, a risk premium is added to the expected return of the investment.
