Call Option Pricing Model and Recovery Theorem: A Specific Case of Pricing Warrants
26 Pages Posted: 11 Dec 2019 Last revised: 23 Dec 2019
Date Written: July 12, 2019
Warrant is normally priced on the basis of Black and Scholes' model, which refers to calculations in a risk neutral world. Hence, it neither captures the market expectation nor being a good reference for the risk management process. This study examines a new way of pricing warrants under the real world probability by utilizing the recovered Vacisek short rate model. Applying Carr and Yu's recovery model, an extended version of Ross Recovery Theorem, we managed to recover the Vasisek process. Then, suppose that the economy is driven by this recovered Vacisek process, we point out a valuation model for the warrant of an underlying stock. We deduce that by applying the recovered Vacisek model we can derive the warrant price under the real world probability without the assumption of the market price of risk as in the risk neutral model.
Keywords: Real-world Probability Warrant Pricing Model, Applied Ross Recovery Theorem, Recovered Vacisek short rate model, Warrants' Risk Management
JEL Classification: C, G
Suggested Citation: Suggested Citation