Pricing New-issue and Seasoned Preferred Stocks: A Comparison of Valuation Models

We compare three alternative models for valuing fixed-rate preferred stocks: the perpetuity model and two models derived from option pricing theory. The parameters necessary to use these models were first approximated using estimation samples of new-issue and seasoned preferred stocks, and subsequently used to price validation samples of preferred stocks. We then compared each model's predicted prices with actual market prices. The results provide strong evidence that the simple perpetuity model more accurately predicts the prices of new issues of preferred stocks. The option models, however, appear to price the seasoned issues better, although the evidence is less conclusive. Overall, the perpetuity model appears to be less sensitive to violations of key assumptions than the OPT-derived models.