Is Warrant Really a Derivative? Evidence from the Chinese Warrant Market

43 Pages Posted: 15 Mar 2010

See all articles by Eric C. Chang

Eric C. Chang

University of Hong Kong - School of Business

Lei Shi

The University of Hong Kong, School of Economics and Finance

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance

Date Written: December 14, 2009

Abstract

China launched her warrant market in August 2005 in the split share structure reform of listed companies. As up to now, equity trading on margin and short-sale of any form are still prohibited in China. This warrant market enables investors to trade on information that otherwise might be prohibitively expensive to trade on. The Chinese warrant market created top trading volume and turnover with only a handful of different warrants traded.

This paper first studies the Chinese warrant market. Empirical evidence shows that the market prices of warrants are much higher systematically than the Black-Scholes prices with historical volatility. Moreover, the paper documents ample evidence that the one-dimensional diffusion model does not apply well in the Chinese warrant market. The prices of a warrant and its underlying asset do not support the monotonicity, perfect correlation and option redundancy properties. The paper also studies the cumulated gains of a delta-hedged warrant portfolio. In the Chinese warrant market, the cumulated delta-hedged gains for almost all expired warrants are negative. The negative gains are mainly driven by the volatility risk, and the trading values of the warrants for puts and the market risk for calls. The investors are trading some other risks in addition to the underlying risk.

Keywords: Warrants, the Chinese warrant market, Option pricing model

JEL Classification: G13

Suggested Citation

Chang, Eric Chieh C. and Shi, Lei and Zhang, Jin E., Is Warrant Really a Derivative? Evidence from the Chinese Warrant Market (December 14, 2009). Available at SSRN: https://ssrn.com/abstract=1570821 or http://dx.doi.org/10.2139/ssrn.1570821

Eric Chieh C. Chang

University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

Lei Shi (Contact Author)

The University of Hong Kong, School of Economics and Finance ( email )

Pokfulam Road
Hong Kong, Hong Kong
China
(852) 6579 4392 (Phone)

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance ( email )

Dunedin, 9054
New Zealand
64 3 479 8575 (Phone)
64 3 479 8171 (Fax)

HOME PAGE: http://sites.google.com/site/jinzhanghomepage/home

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