|
|
|
|||||||||||
|
ENRICO C. PEROTTI University of Amsterdam; Centre for Economic Policy Research (CEPR) JOSEPH A. CHERIAN Boston University - School of Management |
||||||||||||
Abstract: The paper analyses foreign investment and asset prices in a context of uncertainty over future government policy. The model endogenizes the process of learning by foreign investors facing a potentially opportunistic government, which chooses strategically the timing of a policy reversal in order to attract more capital. We characterize the evolution of confidence, investment, and asset prices over time, as well as perceived policy risk. Quite generally, perceived risk abates as current policy is maintained, leading to a gradual appreciation of asset prices and a gradual decrease in their conditional variance. The approach thus provides a measure of the evolution over time of perceived political risk from market prices. We next compute option prices under the process generated by the model's hazard rate of policy reversal plus an additional market risk component. We show that both the time series and the term structure of conditional volatility in general is downward sloping and its overall level falls steadily over time, although it may exhibit initially a hump shape in the case of very low initial reputation. Another testable implication is that in price series without a policy reversal, implied volatility from option prices will exceed actual volatility. Over time, and in the absence of a reversal, this wedge progressively disappears. This may be viewed as the volatility analogue of the "peso premium" for assets subject to large, infrequent price drops.
|
||||||||||||
|
JEL Classifications: F21, F34, G13, G38 |
||||||||||||
|
Working Paper Series |
||||||||||||
|
Abstract has been viewed 783 times |
||||||||||||
|
Go to Download Document Button to download paper from the SSRN Electronic Paper Collection Contact Information for ENRICO C. PEROTTI (Contact Author) [email protected] (Email address for ENRICO C. PEROTTI ) University of Amsterdam Roetersstraat 18 Finance Group Amsterdam 1018 WB Netherlands +31 20 525 4159 (Phone) +31 20 525 5285 (Fax) (No e-mail address available for ENRICO C. PEROTTI ) Centre for Economic Policy Research (CEPR) 90-98 Goswell Road London EC1V 7RR United Kingdom Contact Information for JOSEPH A. CHERIAN [email protected] (Email address for JOSEPH A. CHERIAN ) Boston University - School of Management 595 Commonwealth Avenue Boston , MA 02215 United States 617-353-2679 (Phone) 617-353-6667 (Fax) |
||||||||||||
|
Suggested Citation Perotti, Enrico C. and Cherian, Joseph A., "Option Pricing and Foreign Investment under Political Risk" (September 1999). http://ssrn.com/abstract=162348 |
||||||||||||
|
SSRN Electronic Paper Collection
|
||||||||||||
|
||||||||||||
|
||||||||||||
| Adobe Acrobat Reader v4.05 or Adobe Acrobat 4.0.5 or greater is required to view this paper. To obtain your free copy, click on the Acrobat button | ||||||||||||
Download times are estimates only. Your time to download may be extended due to a poor connection or heavy internet traffic between your location and our servers. | ||||||||||||
|
SSRN Resources To search for other abstracts in the SSRN archival database, click here. |