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Risk Version and Interest Rate Risk

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Applying this same logic to stocks, explain (a) how a decrease in risk aversion would affect stocks' prices and earned rates of return, (b) how this would affect risk premiums as measured by the historical difference between returns on stocks and returns on bonds, and (c) the implications of this for the use of historical risk premiums when applying the SML equation. Support your positions.

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The solution is in a word document explaining the inverse relationship between interest rates and price. It explains why a decrease in risk aversion affects stock prices.

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A decrease in risk aversion is an indication of the investors' optimism regarding the economy and corporate profits, this optimism would be reflected in the decrease of expected returns, and since there is an inverse relationship between interest rates and prices, therefore a decrease in the required rate of return would result in an increase in the prices of stock. When the return on ...

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