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How Does Economic Policy Uncertainty Reshape Option Pricing?

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  • Wenting Chen
  • Rixiang Fei
  • Nana Xu
  • Xin‐Jiang He

Abstract

Economic policy uncertainty (EPU) is a critical yet often neglected factor in derivatives pricing, leading to systematic biases in existing valuation frameworks. This study proposes an advanced pricing model that explicitly incorporates a stochastic EPU factor with a regime‐switching long‐term mean into the stochastic volatility framework. The principal theoretical contribution of this research is a closed‐form analytical pricing formula for European options, which successfully overcomes the challenges of multiple stochastic factors and achieves substantial computational advantages over traditional numerical methods such as the Monte‐Carlo simulation. A preliminary empirical study using SSE 50 ETF option data demonstrates the model's superior pricing performance compared to other benchmarks.

Suggested Citation

  • Wenting Chen & Rixiang Fei & Nana Xu & Xin‐Jiang He, 2026. "How Does Economic Policy Uncertainty Reshape Option Pricing?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 46(7), pages 1298-1311, July.
    • Handle: RePEc:wly:jfutmk:v:46:y:2026:i:7:p:1298-1311
    DOI: 10.1002/fut.70102
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