Researchers have found a positive relationship between default spread and stock returns in the long run because a large default spread implies
A) a high risk premium and higher expected returns.
B) a high risk premium and lower expected returns.
C) a low risk premium and higher expected returns.
D) a low risk premium and lower expected returns.
E) none of the above.

Question

Quizplus · Accepted Answer

A higher default spread indicates a higher risk of default, which translates to a higher risk premium for investors. This higher risk premium leads to higher expected returns in the long run, as compensation for taking on this additional risk. Therefore, choice A is the best answer.

Researchers Have Found a Positive Relationship Between Default Spread and Stock