Is firm-level political risk priced in the equity option market?

Ho, Thang and Kagkadis, Anastasios and Wang, George (2024) Is firm-level political risk priced in the equity option market? Review of Asset Pricing Studies, 14 (1). pp. 153-195. ISSN 2045-9920

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Abstract

We find a negative relation between firm-level political risk and future delta-hedged equity option returns. A quasi-natural experiment based on Brexit corroborates this finding since after the referendum there is a decrease in the option returns of the positive-Brexit exposure firms. The predictability is driven by the jump risk component of political uncertainty, is more pronounced in periods of high intermediary constraints, and is stronger among high-demand pressure options but weaker among politically active firms. Finally, consistent with a risk-based explanation, investors of options on politically risky firms are compensated with high returns when major unexpected political shocks happen.