Abstract
This paper uses the historical simulation approach, similar to that of Green and Figlewski [Journal of Finance 54 (1999) 1465] to investigate the effects of market imperfections and model errors on financial institutions writing derivative warrants. The paper undertakes specific exploration of the effects of particular market imperfections such as transaction costs and the primary market process. An understanding of model risk in the valuation and trading of derivative securities is particularly important for emerging markets, because asset returns are too fat-tailed to be lognormal and errors in volatility forecasts tend to be very significant. Simulation evidence shows that model risk is extremely significant for issuers of derivative warrants in emerging markets such as Taiwan. While exploring possible remedial strategies for market imperfections and model errors, simulation evidence suggests that a search for a better pricing model for the Taiwan derivative warrants market is called for.
Original language | English |
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Pages (from-to) | 55-75 |
Number of pages | 21 |
Journal | Pacific Basin Finance Journal |
Volume | 10 |
Issue number | 1 |
DOIs | |
State | Published - 01 2002 |
Keywords
- Derivative warrants
- Market imperfections
- Model risk
- Up-and-out call