The answer should be B i.e. positively correlated. Risk averse Investors demanding a larger equity premium refers to the investors taking more risk from investing in that asset class. ( Equity in this case). Which inturn implies that Equity is riskier and is a poor consumption hedge…..this is reflected by investors expecting their future outcomes and equity returns to be positively correlated. During good times, they expect equity to perform well, while, during bad times, when better returns are the need of the hour, they perform poorly.
Due to this poor hedging property of equity against bad times, investors demand more equity risk premium from investing in equity as an asset class.
Hello Suraj,
Please refer to this.
Inter Temporal rate of substitution | SSEI QForum
If you still face any issue let me know.
The answer should be B i.e. positively correlated. Risk averse Investors demanding a larger equity premium refers to the investors taking more risk from investing in that asset class. ( Equity in this case). Which inturn implies that Equity is riskier and is a poor consumption hedge…..this is reflected by investors expecting their future outcomes and equity returns to be positively correlated. During good times, they expect equity to perform well, while, during bad times, when better returns are the need of the hour, they perform poorly.
Due to this poor hedging property of equity against bad times, investors demand more equity risk premium from investing in equity as an asset class.