Issuers' credit risk and pricing of warrants in the recent financial crisis

Purpose - The purpose of this paper is to investigate whether factor sensitivities of margins of bank-issued warrants depend on issuers' credit risk during the period of economic turmoil between January 2008 and June 2010. Design/methodology/approach - Therefore, first, Fama-MacBeth estimations were applied and it was demonstrate that the sensitivities of margins in terms of time to maturity and moneyness vary substantially over time; the average outcomes are similar to the results of classical pooled estimations. Findings - Then, time-series tests were used and it was found that the steepness of the issuers' credit default swap (CDS) spread curves correlates negatively with the time-to-maturity sensitivities as well as with the explanatory power of Fama-MacBeth estimations. Research limitations/implications - These findings indicate that the life-cycle hypothesis is weakened when the issuers' CDS spread curves become steeper. Originality/value - Thus, this study offers a new approach to gain insights into the role of issuers' credit risk on price setting behavior.