Valuation of underwriting agreements for UK rights issues: evidence from the traded option market
A recent study by Professor Marsh of the London Business School has estimated that sub-underwriters of rights issues (firms that commit to buy up any remaining shares at the end of a rights issue) make an excess profit of 86% of the fee they charge. Because of this study, the OFT (who originally commissioned it) have argued that underwriting is too expensive and have encouraged firms to reconsider their issuance techniques. Marsh's study, however, is based on a number of assumptions that are unlikely to hold in practice. In particular, Marsh used the Black and Scholes option pricing formula to value the economic cost of underwriting (underwriting is like a put option since it gives the firm the right but not the obligation to sell shares to the underwriter). But it is well known that the Black and Scholes formula is based on a high unrealistic view of financial markets with no transactions costs and no information asymmetries. To make a more realistic estimate of the economic cost of underwriting, this paper looks at the cost of buying put options in the traded option market. This does not mean that buying a put option in the traded option market is a viable alternative to underwriting it simply allows for a more realistic measure of transactions costs. By looking at the price of put options on firms who have just announced a rights issue the paper funds, unsurprisingly, that the true cost of put options was much higher than the Black and Scholes formula predicted. However, it still found that underwriters made an abnormal profit, even if it was only 40% of the fee rather than 86%.
|Date of creation:||Sep 1995|
|Date of revision:|
|Contact details of provider:|| Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH|
Phone: +44 (0)171 601 4030
Fax: +44 (0)171 601 5196
Web page: http://www.bankofengland.co.uk/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Quah, Danny, 1995.
"Measuring Core Inflation,"
CEPR Discussion Papers
1153, C.E.P.R. Discussion Papers.
- Danny Quah & Danny Quah & Shaun P. Vahey, 1995.
"Measuring Core Inflation,"
CEP Discussion Papers
dp0254, Centre for Economic Performance, LSE.
- Roger Beaton & Paul Fisher, 1995. "The Construction of RPIY," Bank of England working papers 28, Bank of England.
- Smith, Jennifer C, 1996.
"Wage Interactions: Comparisons or Fall-Back Options?,"
Royal Economic Society, vol. 106(435), pages 495-506, March.
- Jennifer Smith, 1995. "Wage Interactions: Comparisons or Fall-back Options?," Bank of England working papers 37, Bank of England.
- Joanna Paisley & Chris Salmon, 1995. "How Cyclical is the PSBR?," Bank of England working papers 34, Bank of England.
When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:39. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Publications Team)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.