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Detecting political event risk in the option market

Author

Listed:
  • Kostakis, Alexandros
  • Mu, Liangyi
  • Otsubo, Yoichi

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.

Suggested Citation

  • Kostakis, Alexandros & Mu, Liangyi & Otsubo, Yoichi, 2023. "Detecting political event risk in the option market," Journal of Banking & Finance, Elsevier, vol. 146(C).
    • Handle: RePEc:eee:jbfina:v:146:y:2023:i:c:s0378426622002047
    DOI: 10.1016/j.jbankfin.2022.106624
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    More about this item

    Keywords

    Political event risk; Option-implied information; Risk-neutral distribution; Implied volatility curve; Brexit referendum;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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