The impact of warrant introductions on the behaviour of underlying securities: Australian evidence

Abstract

This paper examines the effects of first-time introduction of warrants by third patty issuers on the trading behaviour of a sample of underlying securities listed on the Australian Stock Exchange (ASX). We document that the introduction of warrants leads to negative abnormal returns and increases in volatility on the underlying stocks. Relative trading volume following warrant introduction is observed to be significantly elevated, where beta risk remains unchanged. These findings lend support to market observers views, who argue that derivative instruments encourage speculation in the underlying instrument. Two explanations are postulated for this occurrence. First, the market is already complete with existing exchange traded options, where the introduction of an additional similar derivative instrument - warrants - fails to provide long-term stability to the underlying stock. Second, given the endogeneity of the warrant listing decision, an elevation in volatility after listing may solely be due to changing market conditions.