The risk-shifting effect and the value of a warrant
AbstractThe exercise of a warrant leads to the well-known dilution phenomenon, the effects of which have been extensively studied over the last four decades. In contrast, the existing literature has paid inadequate attention to the volatility spillover between stockholders and warrant holders. This 'risk-shifting effect' has significant implications for warrant pricing, since any formula that assumes a constant volatility of stock returns produces a bias. In this paper we show that a CEV process with a specific elasticity parameter properly models the stochastic volatility of stock returns for a firm with warrants outstanding. In addition, we propose an approximate analytical formula, exclusively based on observable market variables, that is able to absorb the risk-shifting bias.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Quantitative Finance.
Volume (Year): 10 (2010)
Issue (Month): 10 ()
Contact details of provider:
Web page: http://www.tandfonline.com/RQUF20
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Bajo, Emanuele & Barbi, Massimiliano, 2012. "The role of time value in convertible bond call policy," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 550-563.
- Xiao, Weilin & Zhang, Weiguo & Xu, Weijun & Zhang, Xili, 2012. "The valuation of equity warrants in a fractional Brownian environment," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(4), pages 1742-1752.
- Xiao, Wei-Lin & Zhang, Wei-Guo & Zhang, Xili & Zhang, Xiaoli, 2012. "Pricing model for equity warrants in a mixed fractional Brownian environment and its algorithm," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(24), pages 6418-6431.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael McNulty).
If references are entirely missing, you can add them using this form.