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Mispricing of Chinese warrants

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  • Powers, Eric
  • Xiao, Gang

Abstract

From August 2005 to December 2008, a total of 54 warrants were issued in China. Trading in China's warrant market was extremely active — on a daily basis, turnover often exceeded one. Using three standard pricing models, we document that put warrant market prices averaged 1.2 yuan more than model-generated prices, while call warrant prices averaged 1.9 yuan less. Financial institutions that were authorized to create new warrants exploited these pricing anomalies and generated 20 billion yuan (over $3 billion) in creating overpriced put warrants. We identify two important factors that explain the mispricing. First, we show that the P/E ratios of underlying stocks are related to the overpricing of put warrants and the underpricing of call warrants. This suggests that investors took the potential burst of a stock market bubble into account and thus imposed an implicit discount on the value of stocks when pricing warrants. Second, investors were paying a premium on warrants to fulfill their speculation/trading purposes. Investors also switched from stock trading to warrant trading after an exogenous increase in a stock transaction tax.

Suggested Citation

  • Powers, Eric & Xiao, Gang, 2014. "Mispricing of Chinese warrants," Pacific-Basin Finance Journal, Elsevier, vol. 30(C), pages 62-86.
    • Handle: RePEc:eee:pacfin:v:30:y:2014:i:c:p:62-86
    DOI: 10.1016/j.pacfin.2014.07.002
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    References listed on IDEAS

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    Cited by:

    1. Xiao, Weilin & Zhang, Xili, 2016. "Pricing equity warrants with a promised lowest price in Merton’s jump–diffusion model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 458(C), pages 219-238.
    2. Zhou, Qing & Zhang, Xili, 2020. "Pricing equity warrants in Merton jump–diffusion model with credit risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 557(C).
    3. Neil D Pearson & Zhishu Yang & Qi Zhang & Stijn Van Nieuwerburgh, 0. "The Chinese Warrants Bubble: Evidence from Brokerage Account Records," Review of Economic Studies, Oxford University Press, vol. 34(1), pages 264-312.
    4. Yue, Tian & Zhang, Jin E. & Tan, Eric K.M., 2020. "The Chinese equity index options market," Emerging Markets Review, Elsevier, vol. 45(C).

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    More about this item

    Keywords

    Chinese warrants; Underpricing; Overpricing;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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