Explanation

The correct relationship is: The higher the expected payoff of an asset in bad times, the lower the asset's expected return.

This is based on consumption-based asset pricing theory:

• Bad times refer to periods when consumption is low and marginal utility is high
• Assets that pay off well during bad times provide valuable consumption insurance
• Investors are willing to pay more (accept lower returns) for assets that protect them during economic downturns
• This creates an inverse relationship between expected returns and payoffs during bad times

Key concepts:

• Assets with high payoffs during bad times are like insurance policies
• They command higher prices, leading to lower expected returns
• This explains why defensive stocks (utilities, consumer staples) typically have lower expected returns than cyclical stocks
• The relationship is driven by investor risk aversion and the desire for consumption smoothing