Shanghai Stock Exchange Innovation Laboratory
abstract
The creation of a mechanism is of great significance to the pricing of warrants, and it is a necessary and indispensable institutional measure at this stage in China. The creation mechanism has the dual functions of arbitrage and short selling, which improves the pricing efficiency of warrants, especially plays a very important role in curbing the extreme imbalance between supply and demand.
In the international market, covered warrants issued by securities companies and others occupy an absolute dominant position in the market (accounting for more than 95% of the trading volume). When China launches covered warrants in the future, it is necessary to retain the creation mechanism while introducing the continuous issuance mechanism and free issuance mechanism.
Although the creation mechanism has improved the pricing efficiency of related warrants, in general, the pricing efficiency of China's warrant market is still low, which is related to the defects of the creation mechanism. We propose to further improve the creation mechanism and enhance the flexibility and convenience of creation transactions, such as establishing a real-time creation mechanism similar to Shanghai ETF products, expanding the scope of founders, and establishing a mechanism to create partial cash instead of guarantees.
1、 Introduction
On August 22, 2005, in order to cooperate with listed companies in China Non tradable shares In the reform, Baosteel Warrants were listed on the Shanghai Stock Exchange. So far, 27 warrants have been listed in Shanghai and Shenzhen Stock Exchanges. Warrants are widely welcomed by investors and listed companies because of their advantages such as easy financing, risk hedging and high leverage. However, there are also problems such as the temporary imbalance between supply and demand and the prevalence of speculation. The excessive speculation in the market leads to the sharp deviation of the warrant price from its theoretical value, and the low efficiency of price discovery. Therefore, the pricing efficiency of China's warrant market has become a focus of the market and regulators.
After the listing of Baosteel warrants, there was a serious imbalance between market supply and demand. In order to improve the pricing efficiency of warrants, SSE proposed a warrant creation mechanism, which was implemented in WISCO warrants on November 28, 2005. This paper intends to conduct an empirical study on the role of the creation mechanism in the pricing of warrants, and put forward relevant policy recommendations.
2、 Effective pricing mechanism of warrant market: internal mechanism and external mechanism
Academic circles define price efficiency as: "If a capital market can use all the information obtained in determining asset prices, it is (in terms of information) efficient" (New Palgrave Dictionary of Economics, Volume 2, page 346). It can be seen that pricing efficiency is the core indicator reflecting market efficiency. In an efficient securities market, prices should be able to fully and quickly reflect all available relevant information.
From the perspective of international market practice, warrant pricing mechanism can be summarized as internal mechanism and external mechanism. The internal pricing mechanism means that the market has a spontaneous mechanism that can self correct the wrong pricing, such as arbitrage mechanism and short selling mechanism. External mechanism means that the market has external means to adjust the market price, such as market maker mechanism.
1. Arbitrage mechanism. Arbitrage trading refers to the behavior of "buying and selling the same or substantially similar securities at the same time due to the profit opportunities caused by different prices in different markets". For example, if a certain security is overvalued due to the relevant transactions of irrational investors, the arbitrageur will sell or short the overvalued asset, and at the same time buy other "essentially very similar securities" to realize profits.
If the arbitrage mechanism is very effective and convenient, because the arbitrageurs compete with each other, the asset price will eventually be very close to its real value (within the range of real value plus or minus the arbitrage transaction cost). Therefore, it is precisely because of arbitrage and market competition that the financial market will be effective.
2. Short selling mechanism. When there is a short selling mechanism, if the asset price is overvalued, investors can directly sell the overvalued asset short, thereby lowering the price and promoting the price to return to the true value. Short selling mechanism is a very important means to improve pricing efficiency.
3. Market maker mechanism. Market makers provide bilateral quotations for the securities they make, and assume the obligation to organize market transactions and maintain market stability. Market makers ensure the rationality of the pricing of their market making securities by adjusting the quotation and inventory quantity.
3、 The creation mechanism has the dual functions of arbitrage and short selling, which is an important means for reasonable pricing of warrants
An important condition for the effectiveness of the internal pricing mechanism in the warrant market is that when the warrant price is seriously overestimated (or underestimated), the supply of warrants can be freely increased (or reduced), that is, the market circulation volume is dynamic, thus promoting the price to return to the equilibrium price.
From this perspective, there are mainly two kinds of internal pricing (balancing supply and demand) mechanisms in the international warrant market: the continuous issuance mechanism and the free issuance mechanism. The continuous issuance mechanism means that the original issuer continuously issues its issued warrants, and the terms of the continuously issued warrants and the issued warrants remain unchanged. Free issue mechanism means that one or more issuers can issue multiple warrants for the same underlying security. Continuous issuance and free issuance are widely adopted systems in Hong Kong, Europe and the United States, and are of great significance in balancing market supply and demand and reasonable pricing of warrants.
At the beginning of the introduction of share reform warrant trading, China did not introduce a supporting balanced supply and demand mechanism, which led to a serious imbalance between market supply and demand. Within three months of the listing of Baosteel warrants, the highest daily turnover rate reached 618.28%, the deviation between the actual average transaction price and the theoretical price reached 5000%, and the intraday price fluctuation reached 46.95%, with an average of 11.56%. This shows that there are many problems in the pricing mechanism of Baosteel warrants. Against this background, in order to improve the pricing efficiency of warrants, SSE proposed a warrant creation mechanism, which was officially implemented on November 28, 2005. As of August 25, 2006, there were 388 creation transactions and 129 cancellation transactions in Shanghai Stock Exchange, with 4.099 billion creation transactions and 722 million cancellation transactions respectively.
Creation refers to the mechanism by which market participants (such as securities companies) create warrants with identical terms and codes that can be listed and traded for a listed warrant. In order to control risks, SSE has put forward very strict guarantee requirements for the founders. For example, listed companies issuing put warrants only need to provide 5-10% cash collateral, while the founders must provide 100% guarantee.
The creation mechanism, like the continuous issuance mechanism and the free issuance mechanism, has the dual functions of arbitrage and short selling mechanism, which is of great significance for improving the pricing efficiency of warrants. For example, when the price of warrants is undervalued, investors can make profits by buying warrants and holding them at maturity (or exercising them); When the warrant price is overvalued, the supply can be increased through the creation of a mechanism to automatically stabilize the price. The institution that creates warrants creates and sells warrants when the price is overvalued, and then buys warrants for cancellation when the price of warrants falls, which can play a similar role as "short selling".
The creation mechanism, continuous offering mechanism and free issue mechanism are the main means for the internal pricing mechanism of warrants to play its role. The external mechanism is mainly the market maker mechanism. In the pure quotation transaction mode, the market maker is the determiner of the transaction price, and realizes the market supply and demand balance with its quotation, capital and inventory.
Each of these mechanisms has advantages and disadvantages. Both the creation mechanism and the continuous offering mechanism can directly balance supply and demand, but since the subject of the continuous offering is limited to the initial issuer, the capacity of creation may be limited. The free issuance mechanism can indirectly balance supply and demand, but the process involving issuance will be complex and the cycle will be relatively long. Market maker trading is the most flexible system, but its role is limited when prices fluctuate significantly.
4、 An Empirical Analysis of the Impact of Creation Mechanism on Warrant Pricing Efficiency
We divided the listed warrants into two groups, the creation group and the non creation group, according to the trading situation of all warrants from August 22, 2005, when the first warrant was listed to August 21, 2006, from the pricing efficiency of different groups, the market impact before and after the creation of the creation group, the impact of the creation and cancellation actions on the price stability, and the primary trading firm, The impact of the creation mechanism on the pricing efficiency of warrants is studied.
（1） Comparison of the pricing efficiency of the warrants between the creation group and the non creation group
We compared the premium rate (the ratio between the total exercise cost and the positive share price), the deviation between the actual transaction price and the theoretical price, the implied volatility (the future price fluctuation of the underlying securities predicted by the current price of the warrants), and the intraday excess volatility (the extent to which the intraday price fluctuation of the warrants exceeds the intraday price fluctuation of the positive shares) between the creation group and the non creation group And other indicators. The results show (Table 2) that there is a significant difference in the pricing efficiency between the non creation group and the creation group. Except for the excess volatility, the other indicator creation groups are significantly better than the non creation group. In addition, from the perspective of the deviation between the warrant transaction price and the theoretical price, although there is a serious deviation between the two groups, the non creation group may have a very extreme situation.
In addition, we compared the deviation between the transaction price and the theoretical price of Baosteel warrant (without creation mechanism) and WISCO warrant (with creation mechanism) with similar issuance scale and positive share nature, and found that the deviation between the transaction price and the theoretical price of Baosteel warrant without creation mechanism was significantly greater than that of WISCO warrant with creation mechanism.
Note: The deviation between the closing price or average price in the non creation group and the theoretical price is very large because the theoretical price of individual warrants is close to zero, and the actual price is far greater than the theoretical price. The value in parentheses is the deviation after removing the extreme value; "* * *" means that the significance level tested according to K-W method is 1%, and "*" means that the significance level tested according to K-W method is 5%.
（2） Pricing efficiency changes before and after the creation of the creation group
After the warrants are listed, they may not be created on the day of listing, and the created warrants must be listed and traded on the next trading day after the announcement and creation. For example, the listing date of WISCO warrants was November 23, 2005, but the creation mechanism was implemented only on November 28, 2005. We can judge the impact of the creation mechanism by comparing the changes in market pricing efficiency before and after the implementation of the mechanism.
Table 3 shows that premium rate and intraday price excess volatility have improved significantly after the creation. Although the statistical significance of the difference between the trading price and the theoretical price deviation before and after the creation is not strong, from its mean value, the deviation between the pre creation price and the theoretical price is far greater than the value after the creation, indicating that there was an extreme imbalance between supply and demand (excessive investment) before the creation.
（3） Contribution of creation/cancellation to price stability
We analyzed the contribution of securities firms' selling behavior after establishment and buying behavior before cancellation to the price fluctuation of the day. If the contribution rate of a certain creation or cancellation to price fluctuation is negative or close to zero, it means that its contribution to price fluctuation is small, that is, its contribution to price stability is greater; The opposite is true.
It can be seen from Table 4 that most of the contribution rates of price fluctuations of creation or cancellation transactions are negative or close to zero, the average contribution rate of creation transactions to price fluctuations is 0.08%, and the average contribution rate of cancellation transactions is 0.1%, indicating that they have little impact on price fluctuations and have positive significance for price stability.
（4） Primary dealer behavior and warrant pricing efficiency
China's warrant market requires primary dealers to provide liquidity for warrants. Therefore, if primary dealers can actively perform their obligations, it will help improve the pricing efficiency of the warrant market. However, it is regrettable that the primary dealers failed to give full play to their role in stabilizing the market. Statistics show that the declaration and trading of the eight primary dealers acting as 18 warrants in the Shanghai Stock Exchange are generally not positive enough. Within a year, the average trading days for primary dealers to have quotations are only 81 days, and each primary dealer has only 492 entries per day on average. The number of entries of all primary dealers accounts for only 0.28% of the number of orders placed by all investors; On average, each primary dealer has only 72 transactions per day (33 purchases and 39 sales), and only 492 entries. The transaction amount of all primary dealers accounts for only 0.11% of the total transaction amount. In the Hong Kong market, the proportion of transactions involving buyers or sellers of issuers acting as market makers in the total transaction amount is usually about 70%.
5、 Conclusions and policy recommendations
The study of the creation mechanism on the pricing efficiency of warrants in this paper shows that, on the whole, the creation mechanism has played an important role and is an indispensable institutional measure at this stage in China.
The creation mechanism has dual functions of arbitrage and short selling, which improves the pricing efficiency of warrants. Even though the imbalance between market supply and demand is still serious due to various reasons, the creation of mechanisms has played a very important role in curbing the extreme imbalance between supply and demand. In the absence of other effective means (such as market makers with correct pricing ability), it is essential to create mechanisms to improve the efficiency of warrant pricing.
In the international market, covered warrants issued by securities companies and others occupy an absolute dominant position in the market (accounting for more than 95% of the trading volume), which is also the future development direction of China. When China launches covered warrants in the future, it is necessary to retain the creation mechanism while introducing the continuous issuance mechanism and free issuance mechanism. The creation mechanism has the advantages of short cycle and less limit on creation capacity. Therefore, even if there is a continuous sale mechanism and a free issue mechanism, the creation mechanism still has its significance. Moreover, if there are three mechanisms at the same time, namely, creation, continuous offering and free issuance, the market will choose which mechanism to adopt when to balance supply and demand, which will most help to improve the pricing efficiency of warrants.
Empirical research shows that although the creation mechanism has improved the pricing efficiency of related warrants, the pricing efficiency of China's warrant market is still very low on the whole, which is related to the existence of some defects in the creation mechanism and the failure of primary dealers to play a full role. As of August 2006, the trading volume of warrants caused by the creation and cancellation of the Shanghai Stock Exchange accounted for only about 1% of the trading day and trading volume of relevant warrants related to the creation or cancellation, indicating that the creation and cancellation are not active.
In order to improve the creation mechanism and the pricing efficiency of warrants, we propose to further improve the creation mechanism and enhance the flexibility and convenience of creation transactions.
First, establish a real-time creation mechanism similar to Shanghai ETF products to reduce the uncertainty of arbitrage transactions;
Secondly, expand the scope of founders. At present, only securities companies with innovative pilot qualifications are allowed to create, and the market supply is limited;
Third, establish a cash alternative guarantee creation mechanism. For example, on the day when the warrant is created, if the founder's underlying securities（ shares ）If it is insufficient, it is allowed to replace the insufficient part with cash, but the warrant must be supplemented or cancelled within three days.
(Author: Liu Ti and Ye Wu)
Sina statement: The content of this article is purely the author's personal view, only for investors' reference, and does not constitute investment advice. Investors operate accordingly at their own risk.
