Detecting political event risk in the option market

Alexandros Kostakis, Liangyi Mu and Yoichi Otsubo

Journal of Banking & Finance, 2023, vol. 146, issue C

Abstract: This study shows that the option market can ex ante detect and quantify the effects of political event risk. Focussing on the 2016 UK referendum on EU membership, we find that the Risk-Neutral Distribution extracted from GBPUSD futures options whose expiry spans the referendum date becomes bimodal and the Implied Volatility curve exhibits an unusual W-shape. To the contrary, the corresponding effects for FTSE100 are found to be very limited. The large swings in expectations regarding the event outcome during the referendum night allow us to observe the counterfactual and validate the ex ante information revealed in the option market.

Keywords: Political event risk; Option-implied information; Risk-neutral distribution; Implied volatility curve; Brexit referendum (search for similar items in EconPapers)
JEL-codes: G12 G14 G15 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:146:y:2023:i:c:s0378426622002047

DOI: 10.1016/j.jbankfin.2022.106624

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