Overpriced Chinese Warrants
An interesting article in the Feb 2013 Journal of Financial Markets notes the persistent overpricing of Chinese Warrants. Chang, Luo, Shi, and Zhang, all Chinese academics, examined looked at 47 warrants traded on the Shanghai or Shenzhen exchanges, from 2005-2008. The implied volatilities are about 3 times the historical in their dataset; 150% average implied vs. a 50% average historical volatility.
Above is an anecdote of how the market price tracks a Black-Scholes price given historical volatility as opposed to the market price (blue is market price, magenta is the model price). It's basically impossible to tell a rational story for the market price.
These warrants were all basically options, as they allow continuous creation which allows issuers or other approved institutions to add to supply at at time. As warrants cash settle every day, they make for a popular investment, often with volume far exceeding the underlying equity.
It makes one wonder, if there markets are this unhinged from reality, how uncertain China is as a long term investment. I mean, they are doing a lot of things right, but their institutions aren't exactly promoting rational price discovery. It also highlights that preventing shorting is one of the stupider regulations in the world, because without shorts, stupid prices persist a lot longer.
Above is an anecdote of how the market price tracks a Black-Scholes price given historical volatility as opposed to the market price (blue is market price, magenta is the model price). It's basically impossible to tell a rational story for the market price.
These warrants were all basically options, as they allow continuous creation which allows issuers or other approved institutions to add to supply at at time. As warrants cash settle every day, they make for a popular investment, often with volume far exceeding the underlying equity.
It makes one wonder, if there markets are this unhinged from reality, how uncertain China is as a long term investment. I mean, they are doing a lot of things right, but their institutions aren't exactly promoting rational price discovery. It also highlights that preventing shorting is one of the stupider regulations in the world, because without shorts, stupid prices persist a lot longer.
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