Valuation of Hybrid Stochastic Pricing Models for Equity Warrants: A Comparative Analysis

Abstract

The valuation of warrant pricing models is vital for improving the methodologies employed in the stock market, providing investors with deeper insights for making informed decisions. Traditional methods, such as the Black-Scholes model, often fall short due to assumptions of constant volatility and constant interest rates, leading to inaccuracies in equity warrant valuation. Additionally, existing alternative models have primarily focused on pricing techniques rather than empirical validation. Therefore, there is a pressing need for a mathematical model that incorporates both stochastic volatility and stochastic interest rate to enhance the accuracy of warrant pricing. Recent studies by Roslan et al. (2020) and Roslan et al. (2022) have investigated the pricing of hybrid equity warrants under these stochastic conditions. At present, a comparative analysis to assess the relative effectiveness of these methods has yet to be conducted.This study aims to empirically assess the performance of hybrid equity warrants pricing models in the Malaysian market, considering the influence ofCox-Ingersoll-Ross (CIR) model for stochastic interest rates and the Heston model for stochastic volatility. The algorithm is created for both pricing models, followed by model calibration andstatistical error measurements.Overall, the results indicate that the pricing model developed by Roslan et al. (2022) outperforms Roslan et al. (2020) model in terms of performance and accuracy. However, in terms of execution time, Roslan et al. (2022)’s pricing model recorded 38.12 seconds to 62.62 seconds, whereas the pricing model of Roslan et al. (2020) took 7.25 seconds to 8.19 seconds. The findings of this study will be highly beneficial in quest of a model commonly used by local investment analysts for evaluating equity warrants.