Is it possible for the risk premium to be negative before an investment is undertaken? Can the risk premium be negative after the fact? Explain.


Please answer the following questions:

  1. Risk and Return. We have seen that over long periods, stock investments have tended to substantially
    outperform bond investments. However, it is not at all uncommon to observe investors with long horizons
    holding their investments entirely in bonds. Are such investors irrational?
  2. Risk Premiums. Is it possible for the risk premium to be negative before an investment is undertaken? Can the
    risk premium be negative after the fact? Explain.
  3. Historical Returns. The historical asset class returns presented in the chapter are not adjusted for inflation.
    What would happen to the estimated risk premium if we did account for inflation? The returns also are not
    adjusted for taxes. What would happen to the returns if we accounted for taxes? What would happen to the
    volatility? (This chapter presented returns for a number of different asset classes. The general conclusion is that
    stocks have outperformed bonds over most of the 20th century, though stocks also have exhibited more risk.)



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