If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be goes up.
The investor who favors capital preservation over the possibility of earning a higher-than-average return is referred to as risk-averse. Price volatility is the same as risk in investment. A risky investment has the potential to double or triple your money. Over time, a cautious investment will increase gradually and steadily.
It is logical to predict that the risk premium for the stock market will increase if investors are risk averse.
The slope of the security market line (SML) becomes steeper as the risk premium increases along with risk aversion. As the security market lines become more acute, the required rate of return rises.
Under other words, investors who are risk averse will need to expect an additional return to offset the risk involved with stock ownership. This is because in risk aversion, an investor who chooses capital preservation over the chance of a higher-than-average return is acting rationally.
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