An empirical analysis of the pricing of bank issued options versus options exchange options

Ter Horst, J. and Veld, C. (2008) An empirical analysis of the pricing of bank issued options versus options exchange options. European Financial Management, 14(2), pp. 288-314. (doi: 10.1111/j.1468-036X.2007.00394.x)

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Abstract

Since 1998, large investment banks have become active as issuers of options, generally referred to as call warrants or bank-issued options. This has led to an interesting situation in the Netherlands, where simultaneously call warrants are traded on the stock exchange, and long-term call options are traded on the options exchange. Both entitle their holders to buy shares of common stock. We start with a direct comparison between call warrants and call options, written on the same stock and with the same exercise price, but where the call option has a longer time to maturity. In 13 out of 16 cases we find that the call warrants are priced higher, which is a clear violation of basic option pricing rules. In the second part of the analysis we use option pricing models to compare the pricing of call warrants and call options. If implied standard deviations from options are used to price the call warrants, we find that the call warrants are strongly overpriced during the first five trading days. The average overpricing is between 25 and 30%;. Only a small part of the overpricing can be explained by rational arguments such as transaction costs. We suggest that the overvaluation can be explained by a combination of an active financial marketing by the banks and the framing effect.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Veld, Professor Chris
Authors: Ter Horst, J., and Veld, C.
Subjects:H Social Sciences > HG Finance
College/School:College of Social Sciences > Adam Smith Business School > Accounting and Finance
Journal Name:European Financial Management
ISSN:1354-7798
ISSN (Online):1468-036X
Published Online:24 September 2007

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