What will happen if two assets are earning the same expected return, but one is riskier than the...

Question:

What will happen if two assets are earning the same expected return, but one is riskier than the other?

Risk-Return Relationship:

In a competitive financial market, a positive relationship between risk and return is expected. That is, an asset with a higher degree of relevant risk must offer a higher return to investors.

Answer and Explanation:

If there are two assets with the same expected return, then the one that is riskier will not be attractive to investors, all else the same. Hence, the demand for the asset with higher risk will decrease, reducing the price of the asset and increasing the expected return on the asset. Hence, in equilibrium, the riskier asset will earn a higher expected return.


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