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Black-scholes approximation of warrant prices: slight return in a low interest rate environment

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  • Philippe Bertrand

    (Aix-Marseille Université, CERGAM EA 4225, Aix-Marseille Graduate School of management - IAE, Aix-Marseille Univ., CNRS, AMSE
    KEDGE BS)

Abstract

The objective of this paper is to emphasize the differences between a call and a warrant as well as the different valuation methods of warrants which have been introduced in the financial literature. For the sake of simplicity and applicability, we only consider a debt-free equity-financed firm. More recently a formal distinction between structural and reduced form pricing models has been introduced. This distinction is important whether one wishes to price a new warrant issue or outstanding warrants. If we are interested in pricing a new issue of warrants, e.g. in the context of a management incentive package, one has to rely on a structural model. However most of practitioners use the simple Black-Scholes formula. In this context, we analyze the accuracy of the approximation of the “true” price of a warrant by the Black-Scholes formula. We show that in the current low interest rate environment, the quality of the approximation deteriorates and the sensitivity of this approximation to the volatility estimate increases.

Suggested Citation

  • Philippe Bertrand, 2024. "Black-scholes approximation of warrant prices: slight return in a low interest rate environment," Annals of Operations Research, Springer, vol. 334(1), pages 83-100, March.
    • Handle: RePEc:spr:annopr:v:334:y:2024:i:1:d:10.1007_s10479-022-04622-6
    DOI: 10.1007/s10479-022-04622-6
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    References listed on IDEAS

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    More about this item

    Keywords

    Warrant; Option; Black-Scholes;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles

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