Warrants The Introduction Of Ways To Reduce The Volatility Of The Underlying Stock

It is commonly recognized that warrants play an important role in stabilizing the underlying securities in a mature capital market. However, in emerging markets such as China, whether warrants markets stabilize or destabilize the underlying markets is still doubtful and the effect of the introduction of warrants markets on the underlying market in China capital market has to be proved.In this paper, based on a theoretical and empirical review of relevant studies, I systemically summarized the development and characteristics of warrants market in China. Using 7 samples of listed stocks which issued equity warrants during 2006-2007,I build an EGARCH model to test the change in conditional stock return variance after warrants were introduced. The daily stock return is adjusted by a benchmark yield which is daily industry index return. The evidence shows that warrants introduction, on average, can decrease the level of volatility of underlying stocks although there are some situations where warrants can not stablilize stock return variance.I further analyze the reasons for changes in variance. There are four reasons for a reduction in the variance of stock returns following warrants introductions. Firstly, the existence of warrants trading may also attract speculator from the stock market to the option market. Secondly, new information is generated in the warrants market. Thirdly, warrants improve the efficiency of incomplete asset markets by expanding the opportunity set facing investors and then decrease the systematic risk of market.(Ross (1976) and Wakansson (1982)).Finally, stocks which issued warrants are harder to manipulate. On the other hand, reasons why derivative markets can not stabilize the underlying market are as following: first, the information transmission between warrants and the underlying stocks market is not obvious. Second, there is over-speculation in Warrants market. Last but not the least, many investors in warrants market are immature.In the end of this paper, I give the authorities some suggestions to improve warrants market.