Is Firm-Level Political Risk Priced in the Equity Option Market?

We document a political risk premium of about 0.30% per month in the equity option market. High-political risk firms exhibit delta-hedged returns that are significantly lower than those of low-political risk firms. The effect holds both in a cross-sectional and in a time-series context. A quasi-natural experiment based on Brexit corroborates the result showing that after the referendum there is a decrease in the option returns of the firms with exposure to Brexit risk. Further, the political risk-option return relation is more pronounced among firms with high option demand, high information asymmetry, and high default probability, while it is mitigated for politically active firms. The demand pressure for the options of politically risky firms is driven by the call purchases of public customers and the put purchases of firm proprietary investors. Hence, it appears that due to its heterogeneous nature firm-level political risk is treated differently by different investor groups