Hello, I have a question related to Level II, Portfolio Management, Reading # 50 - Economics and Investment Markets, LOS 50.c.:
As per Schweser 2017, page 185, “the risk aversion of investors can be explained by the covariance of an investor´s intertemporal marginal rate of substitution and expected returns on savings”. For a risky asset (e.g. stocks) this covariance is negative: when the expected future price of the asset is high, the marginal utility of future consumption relative to current consumption is low.
While I do understand this, I don´t understand these sentences: “The resulting negative covariance between the marginal utility of consumption and asset prices REDUCES THE VALUE OF THE ASSET FOR A GIVEN EXPECTED SALE PRICE, P1. Everything else constant, the lower current price (P0) increases expected return. This higher expected return is due to a positive risk premium”.
What does “reduces the value” mean? Does it mean it is cheap relative to future price? Or is there actually a reduction in current prices given future higher prices? Could someone please clarify? Thanks!!