Assume that the following relationship holds in the bond market:
(1+R(0,3))³=(1+R(0,1)+L1)(1+E[R(1,2)]+L2)(1+E[R(2,3)]+L3)
If investors are risk averse, which of the following is true?
All the risk premiums must be zero.
If investors are risk averse, they will not want to hold a risky risk bond
At least some risk premium L must be positive
Investors only care about risk and thus the risk premiums L can be any value, either positive or negetive