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Warrants on the London Stock Exchange: Pricing Biases and Investor Confusion

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  • Gordon Gemmill
  • Dylan Thomas

Abstract

This study of warrants on the London Stock Exchange examines whether they display particular pricing biases and whether investors understand how to value them at the time of issue. In a sample of 72 warrants on closed-end funds (investment trusts) over the 1985–94 period, more than one third of the 12,673 prices are anomalously low. The other two thirds behave like stock options, with lower volatility when they are in-the-money or have a long time until maturity. Despite their frequent undervaluation, it is rational to add warrants to a new equity issue. An examination of 127 new equity issues (95 with warrants) reveals that attaching warrants significantly increases market value. The reason for this appears to be investor confusion: they do not seem to understand that the more the warrants are worth, the less the value of the ordinary shares.

Suggested Citation

  • Gordon Gemmill & Dylan Thomas, 1997. "Warrants on the London Stock Exchange: Pricing Biases and Investor Confusion," Review of Finance, European Finance Association, vol. 1(1), pages 31-49.
    • Handle: RePEc:oup:revfin:v:1:y:1997:i:1:p:31-49.
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    File URL: http://hdl.handle.net/10.1023/A:1009744816785
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    Cited by:

    1. Suchard, Jo-Ann, 2005. "The use of stand alone warrants as unique capital raising instruments," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1095-1112, May.
    2. Suchard, Jo-Ann & Singh, Manohar, 2006. "The determinants of the hybrid security issuance decision for Australian firms," Pacific-Basin Finance Journal, Elsevier, vol. 14(3), pages 269-290, June.
    3. Michael Bleaney, 2004. "Past Returns and Investment Trust Discounts," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(9‐10), pages 1505-1523, November.
    4. Gordon Gemmill & Dylan C. Thomas, 2002. "Noise Trading, Costly Arbitrage, and Asset Prices: Evidence from Closed‐end Funds," Journal of Finance, American Finance Association, vol. 57(6), pages 2571-2594, December.
    5. R. Guy Thomas, 2023. "Long-term option pricing with a lower reflecting barrier," Papers 2302.05808, arXiv.org.
    6. Carlos Miguel Glória & José Carlos Dias & Aricson Cruz, 2024. "Pricing levered warrants under the CEV diffusion model," Review of Derivatives Research, Springer, vol. 27(1), pages 55-84, April.

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