In the capital asset pricing model an increase in investors

In the capital asset pricing model, an increase in investors\' risk aversion will be reflected by a. an increase in the slope of the security market line b. a decrease in the slope of the security market line c. a parallel shift downward in the security market line d. a parallel shift upward in the security market line

Solution

Answer is Option a.

Based on the CAPM Equation,

Required return on stock = Risk free rate + Beta * Market Risk Premium

Market risk premium is the slope of the CAPM graph (Security Market Line). Beta is the x- axis and Required return as y-axis, with risk free rate as intercept on y-axis.

As the investor becomes more risk averse, he would demand greater return. Greater return implies greater return premium. Greater return premium in SML would imply increase in slope of SML.