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Empirical test of the efficiency of the UK covered warrants market: Stochastic dominance and likelihood ratio test approach

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  • Chan, Chia-Ying
  • de Peretti, Christian
  • Qiao, Zhuo
  • Wong, Wing-Keung

Abstract

This paper represents the first attempt to apply a stochastic dominance (SD) approach to examine the efficiency of the UK covered warrants market. Our empirical analyses reveal that neither covered warrants nor their underlying shares stochastically dominate the other, indicating the nonexistence of potential arbitrage gains in either wealth or utility, which implies market efficiency. To complement the SD results, we also employ a likelihood ratio (LR) test to examine information efficiency. A bootstrap methodology is developed to correct the size distortion of the LR test. Our findings show that UK covered warrant returns efficiently reflect the return information of the underlying shares.

Suggested Citation

  • Chan, Chia-Ying & de Peretti, Christian & Qiao, Zhuo & Wong, Wing-Keung, 2012. "Empirical test of the efficiency of the UK covered warrants market: Stochastic dominance and likelihood ratio test approach," Journal of Empirical Finance, Elsevier, vol. 19(1), pages 162-174.
    • Handle: RePEc:eee:empfin:v:19:y:2012:i:1:p:162-174
    DOI: 10.1016/j.jempfin.2011.09.001
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    More about this item

    Keywords

    Covered warrants; Market efficiency; Stochastic dominance; Bootstrap likelihood test;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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