Location of Repository

The Risk-Shifting Effect and the Value of a Warrant

By Emanuele Bajo and Massimiliano Barbi

Abstract

The exercise of a warrant leads to the well-known dilution phenomenon, whose effects have been extensively studied over the last four decades. In contrast, the existing literature has paid inadequate attention to the volatility spillover between stockholders and warrant holders. This “risk-shifting effect ” has significant implications on warrant pricing, since any formula that assumes a constant volatility of stock returns produces a bias, as we document in this paper. We prove that a CEV process with a specific elasticity parameter properly models the stochastic volatility of stock returns for a firm with warrants outstanding. Besides, contrarily to most of the existing warrant pricing approaches, we propose a closed-form formula (exclusively based on observable market variables) able to absorb the risk-shifting bias. JEL classification: G10; G13; G14

Topics: Warrant pricing, CEV models, Risk shifting
Year: 2008
OAI identifier: oai:CiteSeerX.psu:10.1.1.192.6180
Provided by: CiteSeerX
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • http://citeseerx.ist.psu.edu/v... (external link)
  • http://69.175.2.130/%7Efinman/... (external link)
  • Suggested articles


    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.