Working Paper: CEPR ID: DP9822
Authors: Bryan Kelly; Lubo Pastor; Pietro Veronesi
Abstract: 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 Codes: G12; G15; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Political uncertainty (D89) | Option prices (G13) |
| Economic strength (F52) | Value of option protection against political risk (F31) |
| Uncertainty about election outcomes (D80) | Option-market variables (G13) |
| Weak economic conditions (E66) | Value of option protection against political risk (F31) |