The Policy Risk Premium in Equity Derivatives

31 Pages Posted: 28 May 2019

Date Written: April 1, 2019

Abstract

This paper introduces a model that allows to measure the impact of policy risk on the dynamics of the S&P 500 index using option data. I quantify the impact of policy risk on the whole P-distribution of assets, not just on volatility, as most literature on policy risk does. I document that this type of risk is priced and has a sizeable impact on expected returns, volatilities, skewness and kurtosis. A one percent increase in the Economic Policy Uncertainty index leads to a 2.25 percentage points increase in the Equity Risk Premium.

Keywords: political risk, options, equity derivatives, unscented kalman filter, asset pricing, equity risk premium, kalman filter

JEL Classification: G12, G13

Suggested Citation

Vecchio, Giovanni Gabriele, The Policy Risk Premium in Equity Derivatives (April 1, 2019). Available at SSRN: https://ssrn.com/abstract=3380963 or http://dx.doi.org/10.2139/ssrn.3380963

Giovanni Gabriele Vecchio (Contact Author)

Queen Mary University of London ( email )

School of Economics and Finance - Queen Mary, Uni
327 Mile End Road
London, E1 4NS
United Kingdom

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