On the valuation of warrants

Abstract

Abstract This article addresses a misconception in the literature concerning the valuation of warrants when a warrant is treated as an option on the stock of the underlying firm. The magnitude and timing of the impact of a warrant issue on the underlying stock price and on the wealth of the firm's shareholders is examined within a continuous‐time arbitrage‐free economy. In particular, it is shown that the stock price of the underlying firm conditionally reflects dilution at all times following the announcement of a warrant issue and notwithstanding that the warrants might not even have been issued yet. Valuing a warrant or convertible security as an option on the post‐announcement underlying stock price means there is no need for any explicit adjustment for dilution to be made to the chosen option pricing model. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:765–782, 2002

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