What happens to the price of the risk and the price of the stock when an investor becomes risk averse? I don’t think I quite understand this question. Can someone enlighten me please?
When investors become risk averse, they demand more return for the same investment. Assuming that the company isn’t going to be earning any more or less than they were before the investors became risk averse, the only way for this to happen is for the stock price to drop, thereby increasing the return (because the those future earnings will now be based off of a lower initial price). As for the risk of a stock, that’s a trickier question. The risk of the stock from fundamental factors should stay the same, but the return that is required from that stock should increase.