Pricing equity warrants with a promised lowest price in Merton’s jump–diffusion model

Weilin Xiao and Xili Zhang

Physica A: Statistical Mechanics and its Applications, 2016, vol. 458, issue C, 219-238

Abstract: Motivated by the empirical evidence of jumps in the dynamics of firm behavior, this paper considers the problem of pricing equity warrants in the presence of a promised lowest price when the price of the underlying asset follows the Merton’s jump–diffusion process. Using the Martingale approach, we propose a valuation model of equity warrants based on the firm value, its volatility, and parameters of the jump component, which are not directly observable. To implement our pricing model empirically, this paper also provides a promising estimation method for obtaining these desired variables based on observable data, such as stock prices and the book value of total liability. We conduct an empirical study to ascertain the performance of our proposed model using the data of Changdian warrant collected from 25 May 2006 (the listing date) to 29 January 2007 (the expiration date). Furthermore, the comparison of traditional models (such as the Black–Scholes model, the Noreen–Wolfson model, the Lauterbach–Schultz model, and the Ukhov model) with our model is presented. From the empirical study, we can see that the mean absolute error of our pricing model is 16.75%. By contrast, the Black–Scholes model, the Noreen–Wolfson model, the Lauterbach–Schultz model, and the Ukhov model applied to the same warrant produce mean absolute errors of 92.24%, 45.38%, 87.34%, 76.12%, respectively. Thus both the dilution effect and the jump feature cannot be ignored in determining the valuation of equity warrants.

Keywords: Equity warrants; Promised lowest price; Dilution effect; Log-normal jump–diffusion process; Parameter estimation (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S037843711630098X
Full text for ScienceDirect subscribers only. Journal offers the option of making the article available online on Science direct for a fee of $3,000

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:458:y:2016:i:c:p:219-238

DOI: 10.1016/j.physa.2016.03.100

Access Statistics for this article

Physica A: Statistical Mechanics and its Applications is currently edited by K. A. Dawson, J. O. Indekeu, H.E. Stanley and C. Tsallis

More articles in Physica A: Statistical Mechanics and its Applications from Elsevier
Bibliographic data for series maintained by Catherine Liu ().