If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation.

Question

Quizplus · Accepted Answer

When investors hold only one stock, they typically require a higher rate of return to compensate for the higher risk associated with stocks with higher standard deviation. However, when stocks are held in portfolios, the correlation among stocks may reduce the overall risk of the portfolio, so the required return on a stock with a low standard deviation may be higher if it helps to diversify the portfolio.

If Investors Are Risk Averse and Hold Only One Stock