Dilution Effect,Stochastic Volatility,Jump-diffusion And Warrant Pricing

With the continuous reform and the improvement of China's financial system and financial market, the financial derivatives and products have drawn increasing attention. Along with the reform of the split share structure in the stock market, the warrants have returned to China's securities market. They are emerging and non-standard stock options and the first choice of the transitional products to develop the financial derivative market in China. However, because of the imperfections of the warrant market in China and the legislations, as well as the lack of research in warrants pricing theory, non-rational investors and short-selling mechanism, all of them resulted in the non-normal performance and volatility of our warrants prices. At this time, it is very important to price the warrants scientifically and rightly, and thereby to guide and regulate the market behaviors. Since the French mathematician Louis Bachelier used the Brownian motion to describe the stock price movement first and priced the call option in 1900, many western financial and mathematical experts and scholars have put forth a variety of theoretical models and methods, which greatly improve and enrich the pricing of options and warrants theoretical framework. However, whether these theories and models, which were born in well-developed financial markets in Europe and the United States, are really adapted to our warrants market, how are the pricing results of these warrants pricing theories and models in our warrant market, and how to modify and restructure these western pricing theory and models according to China's actual market situation to get best pricing results, are worthy of study and exploration.This article introduced the basic concepts of the warrants in the first place, as well as the situations of developments in domestic and international warrant market, and then gave a detailed review of the pricing theories and models of options and warrants at home and abroad. By loosing the strict assumptions of the theoretical models, and combined with the reality of China's financial market and warrant market, this article analyzed and studied the various factors which affect the warrant pricing. The author found that the dilution effect of the exercising the large amount of single warrant, the random volatilities of underlying stock price as well as big shocks from outside major good or bad news to the stock price are major factors, which great affect warrant pricing in China's warrant market. According to these three major factors that affect warrant pricing, the existing 54 warrants in China warrant market could be divided into three categories: the equity warrants with the dilution effect, the covered warrants with stochastic volatility and the covered warrants of the underlying with jump-diffusion characteristics. Considering the different characteristics of these three warrants, this paper summarized and discussed the existing pricing theories and models of options and warrants to identify the corresponding pricing methods. Next, with the latest sample data of the warrants market in China, this paper used the theoretical models summarized above to perform the empirical researches. Then through the results of the empirical researches, this paper validates and compares the pricing effects of the different theoretical models, and explores and finds the best warrant pricing models and methods which are really suitable for our warrants market. Finally, by analyzing the results of the empirical analysis, the author tried to find out the reasons which result in the differences between the theoretical price and market price and then to make some appropriate policy recommendations.Through the analysis above, we find the following main conclusions. First, in the case of equity warrants issued in a huge quantity, the warrant pricing models with the dilution effect have very good pricing effect in the warrant markets in China, but there is little improvement by revised the constant historical volatility to stochastic volatility; on the contrary, in the case of the equity warrants issued in a small number, the pricing results will be improved by replacing the historical volatility with stochastic volatility. Second, the BS model with the amendment of stochastic volatility could get universally good pricing results for the covered warrants, the results are obviously better than the BS models which are without the volatility amendment. Thirdly, if the underlying stocks in the duration of the warrant have a clear jump, the Jump-diffusion warrants pricing model must be used; neither the classic BS pricing model nor the EGARCH model with the external shocks will have the pricing results as good as the Jump-Diffusion Model. Fourth, if the underlying stock in the duration of the warrants has many slightly jumps, the pricing results of the jump-diffusion pricing models and other models including EGARCH models are rather poor, but the Morton Jump-diffusion pricing model will get a slightly better result than other models.Almost all empirical results of the samples warrants show that the market price of the warrants were higher than the theoretical price and intrinsic value in the warrant market in China. It is mainly due to our limited number of warrants issued, the imbalance between supply and demand, and serious speculations in the warrants market in China. Thus, it is very essential to improve and increase the variety and the numbers of covered warrants, standardize and improve the market system and regulations, and increase the efforts to educate the warrant market participants with the knowledge about warrants. These measures will lay a good foundation for constructing our financial derivative market, which is consisted of financial options, futures and other senior financial derivatives.