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Market Risk Premium and Stock Prices

When the market risk premium rises, stock prices will

a. rise
b. fall
c. recover
d. have excess volatility

Please explain your answer

Solution Preview

When market risk premium rises, stock prices will b. fall- This happens because when the risk premium rises, this takes the people who are risk averse out of the market and more coaxing is needed to get them back. This helps the bond market because there is less risk there and it lowers interest rates in order to get people back into investing. However, less people are investing in stocks and their value falls.

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