Warrant Pricing Using Observable Variables

Abstract

The classical warrant pricing formula requires knowledge of the variance of the firm value process, and the firm value. When warrants are outstanding the firm value itself is a function of the warrant price. Firm value and the variance of the firm value are then unobservable variables. I develop an algorithm for pricing warrants using stock prices, an observable variable, and variance of stock returns. The method also enables estimation of the variance of firm value. A proof of existence of the solution is provided.