Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Question

Quizplus · Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. This is because investors will demand a higher return to compensate for the increased risk. The required rate of return on the market (rM), and the risk-free rate and expected inflation, have not changed, so they will not affect the required rate of return for individual stocks in the market. The required rate of return on a riskless bond may or may not decline, depending on other factors such as changes in interest rates. The required rate of return will not necessarily decline for stocks whose betas are less than 1.0, as this depends on the individual stock's risk characteristics.

Assume That Investors Have Recently Become More Risk Averse, So