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A Note on the Rights Valuation Formula Commonly Presented in Finance Textbooks

Gordon J. Alexander
University of Minnesota - Twin Cities - Carlson School of Management

Alexandre M. Baptista
George Washington University - School of Business



Journal of Applied Finance, Vol. 11, pp. 102-109, 2001

Abstract:     
The approximate rights valuation formula provided in standard corporate finance textbooks is shown to imply the existence of arbitrage opportunities and, for reasonable parameter values, to significantly undervalue rights. The reason why the formula generates such pricing errors is that it ignores the time value of the subscription price and the option value embedded in a right. A discussion and examination of the factors that affect the size of the error is provided. A real-world rights offering example confirms that the approximate formula can lead to substantial pricing errors and suggests that in many circumstances, the approximate formula should be replaced by Smith's (1977) rights valuation formula.

JEL Classifications: G12, G32

Accepted Paper Series

Date posted: January 03, 2002 ; Last revised: May 11, 2009

Suggested Citation

Alexander, Gordon J. and Baptista, Alexandre M., A Note on the Rights Valuation Formula Commonly Presented in Finance Textbooks. Journal of Applied Finance, Vol. 11, pp. 102-109, 2001. Available at SSRN: http://ssrn.com/abstract=285566


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Contact Information

Gordon J. Alexander (Contact Author)
University of Minnesota - Twin Cities - Carlson School of Management ( email )
19th Avenue South
Minneapolis, MN 55455
United States
612-624-8598 (Phone)
612-624-1335 (Fax)
Alexandre M. Baptista
George Washington University - School of Business ( email )
School of Business, Funger Hall, Suite 501
2201 G Street, NW
Washington, DC 20052
United States
202-994-3309 (Phone)
202-994-5014 (Fax)
HOME PAGE: http://home.gwu.edu/~alexbapt/
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