Risk premium explained: What investors are compensated for

A risk premium is the return gap that investors expect for taking on additional risk. It is an expectation, not a promise. Whether it materialises only becomes clear in hindsight.

From 1900 to 2025, Swiss equities returned on average 2.9 percentage points a year more than Swiss bonds (as of 31 December 2025). In the years 2000 to 2009, the opposite was true. Past performance is not a reliable indicator of future results.

What is a risk premium?

Anyone who puts money into an investment whose value fluctuates strongly bears a risk and expects a higher return in exchange than from a low-risk investment. The gap between the two expected returns is called the risk premium. The term has nothing to do with the option premium, which is the price of an option. How the option premium works as a source of income is explained in the article on three sources of regular income.

The key distinction is between expected and realised. The premium describes what is expected in advance. The actual return can be higher or lower.

Four premiums for four risks

The term covers several premiums. In a guest column on Deutsche Börse live (September 2026), fund analyst Ali Masarwah writes that each premium compensates for its own bad times. According to him, equities suffer in recessions and credit suffers in the default cycle. This refers to phases in which many debtors are unable to pay.

Equity premium. It compensates for price fluctuations. Investment expert Luca Liebi of VZ Vermögenszentrum (22 October 2026) names a common measure: the earnings yield of equities minus the yield on ten-year government bonds. The earnings yield is earnings per share divided by the share price. It is one measure among several.

Term premium. The yield on a government bond can be broken down into the expected future short-term interest rates and the term premium. The term premium compensates for the possibility that short-term rates develop differently than expected. In a 2018 working paper, the Swiss National Bank (SNB) examined futures contracts on short-term Swiss franc interest rates (Libor futures). There, the term premium was zero on average. However, it fluctuated over time, and its size grew with interest rate uncertainty. How bond prices react to changes in interest rates is shown in the article on bond prices when interest rates rise.

Credit premium. It shows up in the credit spread, the yield gap between bonds of similar maturity but different creditworthiness. Creditworthiness means how able the debtor is to pay. Usually it is the yield on a corporate bond minus that on a government bond of the same maturity, stated in basis points (one basis point is 0.01 percentage points). Economists at the US Federal Reserve show that expected default risk does not explain the whole spread. They call the remainder, the premium above the expected default, the excess bond premium.

Volatility premium. Volatility is the range within which a price fluctuates. The volatility risk premium compensates for bearing the risk of abrupt changes in this fluctuation. It is estimated through a comparison. On one side is implied volatility, the expected fluctuation derived from option prices (such as the volatility index VIX). On the other side is a forecast of actual fluctuation. How expected fluctuation determines option prices is described in the article on the influence of volatility on option prices.

What figures from Switzerland show

Pictet Wealth Management, the wealth management arm of the Pictet banking group, publishes a study on Swiss equities and bonds ("Schweizer Aktien und Obligationen"). It first appeared in 1988 and has been updated annually since 1998. The 2026 edition covers 1900 to 2025 (as of 31 December 2025). Returns are stated before costs and taxes. The figures are annual averages, calculated with compounding. "Nominal" means before and "real" means after deducting inflation, which averaged 2.1% a year in Switzerland.

In return, equities fluctuated more. The standard deviation of annual returns, a measure of dispersion around the average, was 18.5% for equities and 5.2% for bonds. The worst year brought −34.0% for equities (2008) and −12.1% for bonds (2022). The best year brought +61.4% for equities (1985) and +28.4% for bonds (1922).

The excess return is a gap between two investments that both carry risk, not the gap to cash. Bonds can lose value too, as in 2022. The 2.9 percentage points are therefore not an equity premium in the strict sense. They do, however, show what equities delivered compared with bonds.

When did the premium fail to materialise?

The period makes the difference. The table shows the same comparison for four periods.

Swiss equities and bonds, nominal, according to Pictet (as of 31 December 2025). The last row is our own calculation based on the annual figures in the Pictet table.

Over these ten years, from the end of 1999 to the end of 2009, Swiss equities rose by 12.0% and bonds by 43.6%. Along the way, equities lost 22.0% (2001), 26.0% (2002) and 34.0% (2008). Pictet also counts eight ten-year periods in which Swiss equities delivered a negative return, mainly around the First World War and the stock market crash of 1929.

A separate example from the US: according to the annual figures compiled by Aswath Damodaran (NYU Stern), the S&P 500, an index of large US companies, lost around 1% a year on average from 2000 to 2009, including dividends. Three-month US Treasury bills, short-dated government debt securities, returned around 2.8% a year (our own calculation based on the annual figures). The two examples relate to different markets and cannot be equated.

Risks and limitations

• Losses: A risk premium is not a guarantee. Equities can fall sharply: Swiss equities lost 34.0% in 2008. Bonds can lose value too, by 12.1% in 2022.
• Credit and fluctuation: With the credit premium, there is a risk that the debtor defaults. With the volatility premium, there is a risk of an abrupt rise in fluctuation. Losses are possible in both cases.
• Simultaneous losses: In his guest column of 7 September 2026, Masarwah writes: "There is a state in which everything falls: in liquidity crises." This refers to phases in which investments are difficult to sell. He cites 2008 and 2020 as examples. This is his opinion. According to Pictet, Swiss equities lost value in 37 years since 1900, and in 29 of those years bonds gained. What diversification can achieve and where it reaches its limits is described in the article on diversification.
• Costs and taxes: The figures above do not include them. In Pictet's worked example, CHF 1,000 invested in 1900 grows to only CHF 2 million instead of CHF 3.97 million if costs of 50 basis points are deducted every year.
• Period and measurement: The excess return depends on the period. The Pictet figures apply to Switzerland and cannot be transferred to other markets. The comparison with bonds is not the comparison with cash.
• Numerical example: The values in the example are chosen freely. Actual outcomes will differ.

Conclusion

The risk premium is the expected additional return for bearing a risk, and it consists of several building blocks: the equity, term, credit and volatility premium. From 1900 to 2025, Swiss equities were on average 2.9 percentage points a year ahead of Swiss bonds. The gap varies depending on the period, and from 2000 to 2009 bonds were ahead. The premium is expected; whether it materialised can only be seen in hindsight.