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In: Economics

Define the concept of Risk Premium and what its value would imply regarding risk aversion, risk lover, and risk neutral decision-makers.

Define the concept of Risk Premium and what its value would imply regarding risk aversion, risk lover, and risk neutral decision-makers.

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Expert Solution

CONCEPT OF RISK PREMIUM

It is the return received from an invesntment over and above the risk free return. In other words, it is the extra return earned from an investment beyond the risk free return and is usually calculated by subtracting the risk free return from the actual return of the investmnent.

It is also like a compensation for investors for bearing the extra risk associated with the investment.

It is very useful in calculating the expected return of an investment.

For risk averse investors, risk premium is positive.

For risk neutral investors, risk premium is zero.

And for risk lovers, risk premium is negative.

Rahul Sunny answered 2 years ago
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