The Chinese Warrant Bubble: A Fundamental Analysis

We investigate the information content in Chinese warrant prices based on an option pricing framework that incorporates short-selling and margin-trading constraints in the underlying stock market. We show that Chinese warrant prices can be explained under this pricing framework. On the basis of this new model, we develop a price deviation measure to quantify stock market investors' unobserved demand for short selling or margin trading due to market constraints. We find that warrant-price deviations are driven by underlying stock valuation to a great extent. Chinese warrant prices, save for the time around expiration dates, are better characterized as derivatives than as pure bubbles.