Issuers’ credit risk and pricing of warrants in the recent financial crisis

Abstract

Purpose – The purpose of this paper is to investigate whether factor sensitivities of margins of bank-issued warrants depend on issuers’ credit risk during the period of economic turmoil between January 2008 and June 2010. Design/methodology/approach – Therefore, first, Fama–MacBeth estimations were applied and it was demonstrate that the sensitivities of margins in terms of time to maturity and moneyness vary substantially over time; the average outcomes are similar to the results of classical pooled estimations. Findings – Then, time-series tests were used and it was found that the steepness of the issuers’ credit default swap (CDS) spread curves correlates negatively with the time-to-maturity sensitivities as well as with the explanatory power of Fama–MacBeth estimations. Research limitations/implications – These findings indicate that the life-cycle hypothesis is weakened when the issuers’ CDS spread curves become steeper. Originality/value – Thus, this study offers a new approach to gain insights into the role of issuers’ credit risk on price setting behavior.

Volatility discovery and volatility quoting on markets for options and warrants

“…The information shares reported in Table 3 show that the options market is the informational leader in terms of volatility discovery with an information share highly significant above 0.5, even if all contemporaneous effects are attributed to the warrants market. This finding justifies the use of the options market as a reference market for implied volatilities in the analysis of other retail derivatives markets, as frequently done in the literature (e.g., Baule [2011]; Entrop, McKenzie, Wilkens, & Winkler [2016]; Schertler [2016]; Schertler & Stoerch [2015]).…”

Warrant price responses to credit spread changes: Fact or fiction?

“…The approach we propose here focuses on price changes instead of margins, the measure used in recent studies (e.g. Baule, 2011;Baule & Blonski, 2015;Benet et al, 2006;Chang et al, 2012;Henderson & Pearson, 2011;Schertler & Stoerch, 2015;Stoimenov & Wilkens, 2005;Wallmeier & Diethelm, 2009). An exception is the study by Schertler (2016), who uses difference-in-differences estimations on margins of discount certificates.…”

“…Muck (), Baule and Tallau (), and Entrop, McKenzie, Wilkens, and Winkler (), among others, find strong empirical support for this hypothesis. Using Fama‐MacBeth estimations, Schertler and Stoerch () demonstrate that the time‐to‐maturity sensitivity in margin regressions depends on the issuers’ CS. Therefore, investigating pure price changes might lead to wrong inferences, since the price change might be driven by the fact that time has gone by.…”

“…Our study differs from the recent literature, since we use price changes to examine issuers' pricing patterns, whereas recent studies investigate margins of SFPs to examine the price setting behavior (e.g. Baule, 2011;Baule & Blonski, 2015;Benet, Giannetti, & Pissaris, 2006;Chang, Luo, Shi, & Zhang, 2012;Henderson & Pearson, 2011;Schertler & Stoerch, 2015;Stoimenov & Wilkens, 2005;Wallmeier & Diethelm, 2009). Margin is the relative difference between a product's market price and its theoretical value.…”

Credit risk in derivative securities: A simplified approach

“…Interestingly, while many subsequent papers acknowledge their work, they continue to use the simple model of Hull and White. Papers that cite the Baule et al (2008) paper, but nonetheless use the Hull and White (1995) approach, include Baule (2011), Baule and Tallau (2011), Baule and Blonski (2015), Entrop et al (2016), Schertler (2016), Schertler and Stoerch (2015), Schertler and Stoerch (2018), and Pelster and Schertler (2019).…”