Warrant Pricing Bias in China's Stock Market and Its Causes

Abstract

In this paper we study the characteristics of warrant prices and their formation in China's stock market. We use Hull-White option pricing model (H-W model) to investigate the characteristics of warrant prices, and then adopt the behavior finance theories to study the formation of these characteristics. Our study results show that: all sample warrants have great pricing biases; out-of-the-money warrants are overpriced while in-the-money warrants are underpriced; overpricing of the out-of-the-money call warrant becomes more serious along with the underlying stock price falling; the investors' overconfidence and their overrating of the probabilities of low-probability events are two main causes of these phenomena.