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 larger default spread indicates the market perceives higher credit risk for the company, leading to a higher risk premium for investors. This higher risk premium is expected to result in higher expected returns in the long run. Therefore, the positive relationship between default spread and stock returns is due to a high risk premium and higher expected returns.

Researchers Have Found a Positive Relationship Between Default Spread and Stock