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Under behavioural finance, the possible volatility of Bournelorth Co’s results may lead to
downward pressure on its share price for various reasons. First some investors have
regret aversion, a general bias against making a loss anyway. This, it is claimed,
means that the level of returns on equity is rather higher than the returns on debt than is
warranted by a rational view of the risk of equity.sir what does this mean “warranted by a rational view of the risk of equity”?
We always expect investors to require a higher return from shares than from debt, because there is more risk attaching to their income. Modigliani and Miller derived formulas showing what return shareholders should require depending on the level of gearing. However, their proof assumes that shareholders react rationally/sensibly when considering the risk.
The answer to Bournelorth is saying that maybe some shareholders are more worried about risk than in theory they should be and that therefore the return required may be higher than in theory it should be.
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