Pricing Nikkei index put warrants under fixed and floating exchange rate.

Abstract

The Nikkei Index Put Warrants enable U.S. investors to hedge or speculate on the movements of the Japanese stock market. Understanding the pricing behavior of these derivative securities provides the U.S. investors and issuers with valuable information to assess potential benefits and costs. The earlier study on the Nikkei Index Put Warrants under fixed exchange during 1990 by Chen (1992) shows that there are some pricing, however, those pricing errors are small. Our study uses the BAW model to estimate the theoretical price of five Nikkei Index Put Warrants under fixed exchange rate and one warrant under floating exchange rate, during 1992, the most recent period for those warrants. While the result shows that pricing errors for warrant under floating exchange rate is higher than those under fixed exchange rate, these errors are very small overall. As the market participants gain experience in trading these warrants, the pricing error for warrants under fixed exchange rate during 1992 is much less than that during 1990.