Question

In: Finance

The expected market risk premium is difficult to predict, but theoretically, we know that it depends...

The expected market risk premium is difficult to predict, but theoretically, we know that it depends on:

A. the amount of investors in the market

B. the market's level of greed and fear

C. the market's level of risk aversion and volatility

D. the market's perception of future prospects

Solutions

Expert Solution

OPTION C

Market Risk Premium is the difference between the risk free rate and the expected return from the market which the investor expects. In other words it is the extra return that the investor expects on his security. It is an important part of Modern Portfolio Theory. The slope of the security market line (S.M.L) is represented by Market Risk Premium which is a representation of the Capital Asset Pricing Model (C.A.P.M.). It depends on the market's level of risk aversion and volatility. Because the risk free rate measures the level of risk aversion an investor is willing to take and market return represents volatility. Hence the most important factor on which risk premium depends in nothing but the level of risk aversion and volatility.

jeff jeffy answered 2 years ago
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