For risk-averse investors, what happens to the risk premium as the level of risk increases?

For risk-averse investors, as the level of risk increases, the risk premium tends to increase. This relationship stems from the fundamental principles of risk and return in finance. Risk-averse investors require compensation for taking on additional risk, which is reflected in the risk premium.

When the uncertainty or volatility of an investment's returns rises, risk-averse investors will demand a higher risk premium to be induced to invest in that riskier asset instead of a safer alternative, such as government bonds. This higher risk premium serves as an incentive for them to take on the additional risk, reflecting their preference for stability and lower risk exposure.

Therefore, the correct answer is that the risk premium increases as the level of risk increases, highlighting the intrinsic link between risk and the expected return that investors require.