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) high risk premium and lower expected returns.
C) low risk premium and higher expected returns.
D) low risk premium and lower expected returns.
E) low risk premium and the same expected returns.

Question

Quizplus · Accepted Answer

A larger default spread indicates higher credit risk which implies a higher risk premium for investors. As a result, investors demand higher expected returns to compensate for the increased risk, resulting in a positive relationship between default spread and stock returns in the long run.

Researchers Have Found a Positive Relationship Between Default Spread and Stock