Are Chinese warrants derivatives? Evidence from connections to their underlying stocks

Ke Tang and Changyun Wang

Quantitative Finance, 2013, vol. 13, issue 8, 1225-1240

Abstract: In this paper, we empirically investigate warrant price behaviour in the Chinese market—the largest warrant market in the world in terms of trading volume since 2006. By examining warrant return properties, volatility behaviour and pricing errors, we document a stylized fact that call warrants have a considerable linkage with their underlying but put warrants have almost none. The combination of the arbitrage pricing theory and the resale-option bubble theory (proposed by Scheinkman and Xiong in 2003) is adopted to explain this stylized fact. Specifically, the arbitrage pricing framework tells that it is possible for puts (calls) to be overpriced (underpriced) due to short-sales prohibition in the Chinese stock market, while the resale-option bubble theory proves that puts do have bubbles but calls do not. The bubble dilutes the linkage between put prices and their underlying stock prices. Our findings have implications for Chinese investors as well as the derivatives regulator.

Date: 2013
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DOI: 10.1080/14697688.2012.740570

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