Study On Bias Between Actual And Theoretical Price Of Chinese Warrants

After nine years' break, the market of warrants restarted in August 2005, and it immediately drew high attention of investors. As a new method of high-leverage investment, it caters for some risk-preferred investors, enriches exchange strategies, and makes financing ways more efficient. However, the functions of discovering price, hedging and avoiding risk, should be involved in warrants, is hard to be found in Chinese warrants market. Instead, the market shows huge trading volume, velocity of hundreds percent and even more, intensive fluctuations before deadline. Warrants market is filled with speculation, some warrants without any value can be driven up several times in a day, and the price of warrants has gone far away from its value. Theoretically speaking, the price of warrants has little possibility to be apart from its theoretical price. The theoretical price is get in equilibrium under non-arbitrage condition, if there is bias between the actual price and theoretical price, the investor can get profits without taking risks, and the arbitrage will eliminate the bias in a short time. Some factors like risk preference or profit anticipation can affect the price of stock, but hard to affect the price of warrants continuously. So the significant pricing biases in Chinese warrant market is rare in the world, which deserves further research for Chinese scholar.This paper calculated theoretical price of all the 41 listed warrants (until 2007-12-31), based on Black-Scholes pricing model, and took dilution effect into consideration. Compared with the actual price, we find that it is very common to overestimate the warrants. The call warrant is average 50% departed from its theoretical price after obliterating some special samples, but high correlation with underlying stock; the put warrants is average 1000% overestimated, and it is nearly independent of underlying stock. The reason of pricing bias is that, arbitrage is hard to be applied in warrant market because of the lack of short sale strategy. Investor behavior outside the model can continued affect the price of warrants in that case. The deficiency of warrant supply, the finitude of financial knowledge of investors and the faultiness of exchange system directly lead to irrational behaviors. In addition, the warrants creation system should help to increase supply and restrain speculation, but in fact, the average bias rate of warrants these can be created are higher than those can not be created. On the contrary, the creation system intensifies the bias, because the securities companies can benefit a lot from create warrants. They are easier to manipulate price of warrant, and likely become a speculator in the drive of benefit.This paper also analyzes difference between call and put warrant market, and explains the difference comes from the diversity of in and out the money. The bull market in the past two years has lead to call warrants deep in the money and put warrant deep out the money. Put warrants with low price and high leverage is easier to speculate, so put warrant market is more irrational.This study is significant for evaluating whether the warrant market is healthily developed, for involved departments to help investor correct unscientific warrant investment. This paper will provide new thoughts for warrant researchers. It is also useful for the study and development on financial derivatives.