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

We empirically analyze the pricing of political uncertainty, guided by a theo- retical 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. 

Authors: 
Bryan T. Kelly, University of Chicago Booth School of Business
Lubos Pastor, University of Chicago Booth School of Business
Pietro Veronesi, University of Chicago Booth School of Business
Publication Date: 
January, 2014
Publication Status: 
Document Number: 
2014-001