Issuers’ credit risk and pricing of warrants in the recent financial crisis
Abstract
Purpose
The purpose of this paper is to investigate whether factor sensitivities of margins of bank-issued warrants depend on issuers’ credit risk during the period of economic turmoil between January 2008 and June 2010.
Design/methodology/approach
Therefore, first, Fama–MacBeth estimations were applied and it was demonstrate that the sensitivities of margins in terms of time to maturity and moneyness vary substantially over time; the average outcomes are similar to the results of classical pooled estimations.
Findings
Then, time-series tests were used and it was found that the steepness of the issuers’ credit default swap (CDS) spread curves correlates negatively with the time-to-maturity sensitivities as well as with the explanatory power of Fama–MacBeth estimations.
Research limitations/implications
These findings indicate that the life-cycle hypothesis is weakened when the issuers’ CDS spread curves become steeper.
Originality/value
Thus, this study offers a new approach to gain insights into the role of issuers’ credit risk on price setting behavior.
Keywords
Acknowledgements
The current version has benefited from comments by two anonymous referees. The authors are indebted to Piet Usselmann, and participants at the PhD workshop in Paderborn 2014 and at the Midwest Finance Association Annual Meeting for their valuable comments on an earlier version of this work. The authors retain sole responsibility for all remaining errors. The authors thank ARIVA.DE AG for providing information on issuing activities and quoted prices of warrants. Furthermore, the authors thank Eoin Ryan for editing.
Citation
Schertler, A. and Stoerch, S. (2015), "Issuers’ credit risk and pricing of warrants in the recent financial crisis", Journal of Risk Finance, Vol. 16 No. 4, pp. 444-462. https://doi.org/10.1108/JRF-12-2014-0174
Publisher
:Emerald Group Publishing Limited
Copyright © 2015, Emerald Group Publishing Limited