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Black-scholes approximation of warrant prices: slight return in a low interest rate environment

Abstract : The objective of this paper is to emphasize the differences between a call and a warrant as well as the different valuation methods of warrants which have been introduced in the financial literature. For the sake of simplicity and applicability, we only consider a debt-free equity-financed firm. More recently a formal distinction between structural and reduced form pricing models has been introduced. This distinction is important whether one wishes to price a new warrant issue or outstanding warrants. If we are interested in pricing a new issue of warrants, e.g. in the context of a management incentive package, one has to rely on a structural model. However most of practitioners use the simple Black-Scholes formula. In this context, we analyze the accuracy of the approximation of the “true” price of a warrant by the Black-Scholes formula. We show that in the current low interest rate environment, the quality of the approximation deteriorates and the sensitivity of this approximation to the volatility estimate increases.
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https://hal-amu.archives-ouvertes.fr/hal-03646980
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Submitted on : Wednesday, April 20, 2022 - 10:20:01 AM
Last modification on : Friday, April 22, 2022 - 3:40:07 AM

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Philippe Bertrand. Black-scholes approximation of warrant prices: slight return in a low interest rate environment. Annals of Operations Research, Springer Verlag, In press, ⟨10.1007/s10479-022-04622-6⟩. ⟨hal-03646980⟩

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