The Price of Political Uncertainty: Theory and Evidence from the Option Market
68 Pages Posted: 2 Jun 2014
Date Written: February 2014
We empirically analyze the pricing of political uncertainty, guided by a theoretical model of government policy choice. After deriving the model's predictions for option prices, we test those predictions in an international sample of national elections and global summits. We find that political uncertainty is priced in the option market in ways predicted by the theory. Options whose lives span political events tend to be more expensive. Such options provide valuable protection against the risk associated with political events, including not only price risk but also variance and tail risks. This protection is more valuable in a weaker economy as well as amid higher political uncertainty.
Keywords: options, political uncertainty
JEL Classification: G12, G15, G18
Suggested Citation: Suggested Citation