The Dynamics of Overpricing in Structured Products
47 Pages Posted: 19 Mar 2011 Last revised: 21 Nov 2011
Date Written: September 22, 2011
Abstract
Issuers of structured products have great power when setting the price of their securities. Each issuer is the sole liquidity provider in the secondary market for her products, and short-selling is not possible. Using a large, high-frequency data set, we investigate the pricing dynamics of a class of structured products, bank-issued warrants, and show that issuers use their monopoly powers to extract wealth from investors. First, we find that warrants are more overpriced the harder they are to evaluate, and the fewer substitutes are available. Second, issuers are able to anticipate demand in the short term and preemptively adjust prices for warrants upwards (downwards) on days when investors are net buyers (sellers). Third, issuers decrease the amount of overpricing over the lifetime of most warrants, lowering returns for investors further. Lastly, while we find a negative relationship between issuer credit risk and overpricing, the effect is generally too small, is absent prior to the Lehman Brothers bankruptcy and does not conform to models of vulnerable options. Thus, issuers gain access to cheap financing.
Keywords: Structured Products, Default Risk, Retail Investors, Overpricing
JEL Classification: G11, G13, G21, G33
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Alternative Market Structures for Derivatives
By Söhnke M. Bartram and Frank Fehle
-
Competition Without Fungibility: Evidence from Alternative Market Structures for Derivatives
By Söhnke M. Bartram and Frank Fehle
-
Does Adverse Selection Affect Bid-Ask Spreads for Options‘
By Söhnke M. Bartram, Frank Fehle, ...
-
Investors with Too Many Options?
By Daniel Dorn
-
Investors with Too Many Options?
By Daniel Dorn
-
The Trade-Off Between Liquidity and Precision of Position in Option Contracts
-
The Demand for Warrants and Issuer Pricing Strategies
By Rainer Baule and Philip Blonski
-
The Effect of Issuer Leverage on Issuer Bid and Ask Quotes for Structured Retail Product
By Stefan Petry