The term premium is the extra expected return that investors require for holding longer-term bonds. It is the portion of a long-term bond's yield that compensates for the risk and uncertainty of future interest rates beyond the path of expected short-term rates.
In research and market analysis, the term premium is used to decompose a yield curve into an expected short-rate component and a premium for bearing rate risk over time. Analysts estimate the term premium by comparing the forward rates implied by current yields to forecasts of future short rates, or by applying fixed-income models that separate the yield into an expected path and a risk-based component. Changes in the term premium can reflect shifts in investor risk appetite, expectations for inflation, or perceived uncertainty about monetary policy.
The term premium is a key element of the term structure of interest rates and appears in several pricing and economic models, including those that extend the expectations hypothesis to include a risk premium. It is not directly observed as a single number but is inferred from yields, surveys, and model-based decompositions.
Example: A researcher notes that the 10-year yield is higher than the forward rate implied by the yield curve; the difference is attributed to the term premium.
Yield curve · Term structure of interest rates · Forward rate · Interest rate risk · Inflation expectations · Risk premium