Warrant introduction effects on stock return processes

Abstract

As the underpricing of warrants remains unsolved after many adjustments presented by previous researchers, we further investigate the impact of the warrant introduction on the underlying stock return processes. This research attempts to determine whether the introduction of warrants influences the return processes of underlying stocks. If the introduction creates a potential dilution effect on stock return process, full dilution adjustment pricing models would lead to underpricing. To examine whether full dilution adjustment is required for warrant pricing, the Generalized Autoregressive Conditional Heteroscedasticity in Mean (GARCH-M) model has been extended to derive four models for testing the dilution effect on stock return processes. Empirical results show that the volatilities of underlying stock return processes are significantly reduced following warrant introduction even after distinguishing dilution from asymmetric effect.