The Demand for Warrants and Issuer Pricing Strategies
Journal of Futures Markets, forthcoming
53 Pages Posted: 18 Aug 2011 Last revised: 19 Oct 2014
Date Written: July 27, 2014
We develop a model for the demand of warrants by individual investors with regard to their sensitivity to issuer margins, defined as the relative overpricing with respect to the theoretical value. Based on an empirical data set we show that investors are relatively margin-sensitive; that is, given similar warrants from different issuers or warrants with similar characteristics, investors tend to buy those with the lowest margin. Investors are, however, not absolutely margin-sensitive; that is, demand is not influenced by the overall margin level. Our model suggests an equilibrium with different issuer pricing strategies for different warrants in such a situation. Consistent with the model's predictions, we find that issuers vary their pricing with the moneyness of a warrant. We thus give an explanation for the dependence of issuer margins on a product's moneyness, which has been documented in the literature for several retail derivative products.
Keywords: bank-issued options, price sensitivity, retail derivatives, retail investors, warrants, optimal pricing strategies
JEL Classification: G11, G12, G13, G21
Suggested Citation: Suggested Citation