The Impact Of Economic Policy Uncertainty On Options Market-evidence From S&P 500 Index Options

The economic policies of a country or region have a significant impact on its macroeconomic development and the operation of financial markets.Options,as an important financial derivative in the market,are a good hedging tool for the subject spot investor.When economic policy uncertainty increases,investors fear that they will suffer losses as a result of asset price fluctuating,and they can evade risk by buying options.Options provide the price risk,variance risk and tail risk protection for the underlying asset.However,such protection is costly.The costs of these three kinds of protection respectively correspond to larger implied volatility,variance risk premium and the slope of volatility smirk.This article uses S&P 500 index options market data and Economic Policy Uncertainty index(EPU index)constructed by Baker et al.(2016)to study the impact of economic policy uncertainty on the three key indicators of options market(implied volatility,variance risk premium and slope of volatility smirk).Empirical results show that economic policy uncertainty is priced in the S&P 500 index options market.Meanwhile,this article also examines whether EPU index has predictive power on the three option indicators.The results of in-sample forecast indicate that EPU index can significantly predict the implied volatility,short-term variance risk premium and slope of volatility smirk of put options.The results of out-of-sample forecast show that EPU index has a significant out-of-sample point predictive power for implied volatility,as for out-of-sample interval forecast results of EPU index on implied volatility,the univariate case is satisfied while the multivariate case is not.EPU index has significant out-of-sample point and interval predictive power for both short-term variance risk premium and slope of volatility smirk of put options.Finally,we constructs the VIX futures trading strategy based on the EPU index.This strategy can achieve high returns with simple and effective trading signals,and it can also be used as a hedging strategy of equity strategies.