In accounting, market risk premium basically has two distinct meanings: “market risk” premium and market “risk premium“.

A “market risk” premium is defined as the premium for overall market risk. In other words,  it represents the additional/ excess amount of return (or observed market return or rate of return) over and above a reference risk-free rate (RFR). Market risk, from an accounting perspective, is the risk that arises from any fluctuations in the fair value of a financial instrument or future cash flows associated with it, due to changes in market prices. This premium is estimated in light of the evidence about transaction price (fair value-based market price of a transaction): if the evidence indicates that a transaction is not orderly, the transaction price would not be given much weight as an indicator of fair value (compared with other indicators available. Otherwise, for an orderly transaction, a transaction price would be taken into consideration, in view of multiple factors such as volume, proximity to measurement date, etc.

On the other hand, market “risk premium” is the risk premium for a specific type of risk that the market assigns to a specific instrument or transaction exposed to the respective type of risk. Examples are market “risk premium” for credit risk, market “risk premium” for liquidity risk, etc. For example, credit risk premium the premium for the risk that a financial loss will be incurred by a party to a financial instrument (or broadly any financial arrangement) due to failure by the other party to discharge an obligation. Credit risk may take the form of potential loss that may arise due to failure by a borrower to repay a loan.