DP9822 The Price of Political Uncertainty: Theory and Evidence from the Option Market

Author(s): Bryan Kelly, Lubos Pástor, Pietro Veronesi
Publication Date: February 2014
Keyword(s): options, political uncertainty
JEL(s): G12, G15, G18
Programme Areas: Public Economics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9822

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.