Whalley, A. Elizabeth (2011) Covered warrant valuation: a costly hedging model. Working Paper. Warwick Business School, Financial Econometrics Research Centre, Coventry. (Unpublished)

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Abstract

We provide a new, supply-side explanation for the consistent, statistically significant, empirical observation that covered warrant prices are higher than those of corresponding traded options. Covered warrant market-makers, who set prices, are also the issuers and always have net short positions. Their reservation prices for redeeming or issuing more warrants reflect the change in their total hedgingrelated costs. For overall net short positions we show both bid and ask reservation prices lie above perfect-market values, since transaction costs increase both issuers’ marginal costs of warrant issuance and the marginal benefits of warrant redemption. The model generates prices and bid-ask spreads consistent with existing empirical evidence and also new testable implications.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	H Social Sciences > HJ Public Finance
Divisions:	Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School
Publisher:	Warwick Business School, Financial Econometrics Research Centre
Place of Publication:	Coventry
Date:	2011
Number of Pages:	42
Status:	Not Peer Reviewed
Publication Status:	Unpublished
Access rights to Published version:	Restricted or Subscription Access
URI:	http://wrap.warwick.ac.uk/id/eprint/44895

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