Pricing of local equity warrants using black-scholes model

Abstract

The Singapore stock market is discovering the potential of local equity warrants. In recent years, frenetic interest in the warrant market has caused its trading levels to reach new heights. With regard to this encouraging phenomenon, it is important that investors understand the nature of warrant, in particular, it's pricing, in order to benefit from the advantages inherent in the warrants. Various models were developed to price warrants. Of these, BlackScholes Model [1973] presented a market equilibrium option valuation model which does not require knowledge of investors' taste nor their beliefs about the expected returns on the option or on the underlying common stock. This study looks into the effectiveness of the Black-Scholes Model in pricing local equity warrants. The results of the authors' study show that on average, the Black-Scholes Model tends to underprice the actual warrant prices. More detailed analysis indicates that the model offers better predictions of the actual market prices for in-the-money warrants than out-of-the-money warrants .