Abstract: Previous literature finds that stocks with low market skewness risk outperform stocks with high market skewness risk. Using the portfolio sort approach, we show that this market skewness risk premium is much more pronounced among stocks with low default risk or under good economic conditions. The premium vanishes among stocks with high default risk or under poor economic conditions. Further, the market skewness risk is negatively priced only for stocks with low default risk or in good economic times. It is not priced when firm-level default risk is high or when macroeconomic conditions are bad. Our findings suggest that the market skewness risk premium and the pricing of market skewness risk are conditional on both firm-level default risk and country-level macroeconomic conditions. This is because investors’ aversion to default risk and downside market risk changes their attitudes towards positive market skewness risk.

Keywords: Asset pricing, Positive skewness preference, Market skewness risk premium, Default risk, Macroeconomic conditions, State-dependent risk aversion