Warrant price responses to credit spread changes: Fact or fiction?

• Author: Saskia Stoerch,Andrea Schertler
• Date: 01 July 2018
• Published date: 01 July 2018
• DOI: http://doi.org/10.1016/j.rfe.2017.03.002

ORIGINAL ARTICLE

Warrant price responses to credit spread changes: Fact or

fiction?

Andrea Schertler

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Saskia Stoerch

Leuphana University, Scharnhorststr.1,

21335 L€

uneburg, Germany

Correspondence

Andrea Schertler, Leuphana University,

Scharnhorststr.1, 21335 Lüneburg,

Germany.

Email: schertler@leuphana.de,

saskia.stoerch@leuphana.de

Abstract

We use a new approach to analyze the relationship between warrant prices and

issuers’credit spreads. This approach allows us to gain insights into whether

issuers use their credit risk systematically to increase their profits. In a post-Leh-

man sample, we find strong support for a systematic use since issuers decrease

prices less after cred it spread increases than they increase prices after credit

spread decreases. Credit spread decreases are accompanied by price increases on

several successive days. This sluggish adjustment in prices can be explained by

the fact that retail investors’purchase decisions depend on product prices.

JEL CLASSIFICATION

D40, G13, G15

KEYWORDS

Credit spreads, Overshooting, Price changes, Sluggish adjustment, Warrants

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INTRODUCTION

Retail investors face several limitations when investing in capital markets, since they cannot combine securities avail able to

institutional investors due to market barriers and other bottlenecks. Therefore, several investment banks and large universal

banks offer structured financial products (SFPs) to provide retail investors with products that have payoff structures similar

to the ones institutional investors can buy or create by bundling securities traded at various exchanges to which retail inves-

tors have limited access. These SFPs are unsecured securities of the issuing institutions, and for this reason, retail investors

purchasing these products are exposed to the issuers’credit risk. Recent studies argue that the credit risk of issuers gives

them leeway when it comes to pricing these products because retail investors likely have difficulties determining the full

implications of issuers’credit risk on products’values (e.g. Baule, Entrop, & Wilkens, 2008). This study proposes a new

approach to gain insights concerning the relationship between product prices and issuers’credit risk by determining how

sensitive price changes of these products respond to contemporaneous and lagged changes in credit spreads (CS) of issuing

institutions.

Our study differs from the recent literature, since we use price changes to examine issuers ’pricing patterns, whereas recent

studies investigate margins of SFPs to examine the price setting behavior (e.g. Baule, 2011; Baule & Blonski, 2015; Benet,

Giannetti, & Pissaris, 2006; Chang, Luo, Shi, & Zhang, 2012; Henderson & Pearson, 2011; Schertler & Stoerch, 2015; Stoime-

nov & Wilkens, 2005; Wallmeier & Diethelm, 2009). Margin is the relative difference between a product’s market price and

its theoretical value. Theoretical values are often determined by applying the model by Black and Scholes (1973), which does

not consider issuers’credit risk, or the one by Hull and White (1995), which takes it into account. Using price chang es instead

of margins has two main advantages. First, information on price changes can be readily obtained, and do, therefore, not depend

First published online by Elsevier on behalf of The University of New Orleans, 14 March, 2017, https://doi.org/10.1016/j.rfe.2017.03.002

Received: 13 April 2016

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Revised: 2 March 2017

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Accepted: 11 March 2017

DOI: 10.1016/j.rfe.2017.03.002

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©2017 The University of New Orleans wileyonlinelibrary.com/journal/rfe Rev Financ Econ. 2018;36:206–219.