The Price of Political Uncertainty: Theory and Evidence from the Option Market

TLDR

The study empirically analyzes how political uncertainty is priced, using a theoretical model of government policy choice. The authors isolate political uncertainty by exploiting its variation around national elections and global summits, guided by a theoretical model of government policy choice. The study finds that political uncertainty is priced into equity options, with options covering political events being more expensive and offering protection against price, variance, and tail risks, especially in weaker economies and higher uncertainty, and that these effects spill over across countries.

Abstract

ABSTRACT We empirically analyze the pricing of political uncertainty, guided by a theoretical model of government policy choice. To isolate political uncertainty, we exploit its variation around national elections and global summits. We find that political uncertainty is priced in the equity option market as predicted by theory. Options whose lives span political events tend to be more expensive. Such options provide valuable protection against the price, variance, and tail risks associated with political events. This protection is more valuable in a weaker economy and amid higher political uncertainty. The effects of political uncertainty spill over across countries.