Abstract
We review recent European warrant pricing theory that accounts for other securities in the capital structure of the firm, besides the stock and a warrant. An individual who owns a European warrant determines his exercise policy in equilibrium taking into account any transfer of wealth between stockholders and holders of other non-expiring securities. As a result, the equilibrium exercise policy differs from the textbook call-like policy. The equilibrium exercise policy depends on the direction of wealth transfer. We derive the competitive equilibrium policy and demonstrate how it can be computed.
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Nikunj Kapadia—The paper has benefited from comments of N. Chidambaran, Hossein Kazemi, George Martin, Sanjay Nawalkha, N. R. Prabhala, Raghu Sundaram, seminar participants at Georgetown University, University of Maryland, and the University of Virgina. I thank Xiaoling Pu for computational assistance. The paper includes results that were previously circulated in a paper titled Dilution and the Valuation of Options and Non-Identical Warrants.
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Kapadia, N., Willette, G. Equilibrium exercise of European warrants. Rev Deriv Res 15, 129–156 (2012). https://doi.org/10.1007/s11147-011-9072-7
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DOI: https://doi.org/10.1007/s11147-011-9072-7