N°26-68: Risk Prudence Premia

We attribute the coskewness premium in the cross-section of equity portfolios, the negative variance risk premium, and the downward-sloping implied volatility skew to one common source, risk prudence, the aversion to downside risk. The discount factor in a minimum-divergence economy with skew-normal factor payoffs delivers this dependence through a single parameter. A decomposition into a symmetric and a downside-risk channel yields their prices of risk, estimated on U.S. characteristic-managed portfolios. The estimates have the signs the model predicts in the cross-section and in index and sector-fund options.