New Warrant Issues Valuation with Leverage and Noisy Equity Values

Abstract

The empirical analysis of new warrant issues in the context of a structural model of the firm typically assumes the absence of debt and a perfect equity pricing model. We examine here an approach relaxing these two assumptions. The proposed approach develops simple analytical expressions for the prices of warrant, debt and equity in the presence of leverage. An empirical strategy is proposed to implement the model with equity prices containing model errors. An illustration with a recent warrant issue deal between Bank of America and Berkshire Athaway is provided.

Keywords: Warrants, structural model, extended Kalman filter

JEL Classification: G12, C13, C52, C22