WARRANT PRICING USING OBSERVABLE VARIABLES

The classical warrant pricing formula requires knowledge of the firm value and of the firm-value process variance. When warrants are outstanding, the firm value itself is a function of the warrant price. Firm value and firm-value variance are then unobservable variables. I develop an algorithm for pricing warrants using stock prices, an observable variable, and stock return variance. The method also enables estimation of firm-value variance. A proof of existence of the solution is provided. 2004 The Southern Finance Association and the Southwestern Finance Association.