Which statement about risk premiums is correct regarding a risk-averse investor?

A risk-averse investor is someone who prefers to minimize uncertainty and avoid risky investments if possible. When we talk about risk premiums in relation to this type of investor, we refer to the additional return that these investors demand as compensation for taking on risk.

The correct statement regarding a risk-averse investor is that the risk premium increases. This is because risk-averse investors require a larger premium to accept the uncertainty associated with riskier investments compared to less risk-averse individuals. As the perceived risk of an investment rises, these investors will expect a higher risk premium in return for taking on that additional risk. This higher expected return compensates them for the discomfort associated with bearing uncertainty.

In scenarios where risk is high, the demand for a higher return becomes more pronounced, leading to an increase in the risk premium. This behavior reflects their risk aversion, as they seek to ensure that the potential upsides of investing in riskier assets adequately compensate them for the potential downsides.