A contingent claims analysis of the pricing of rights isssues with discontinuous diffusion processes

Master Thesis

1998

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University of Cape Town

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Abstract
This research proposed to identify the most accurate method of pricing rights using option pricing models, including the Black Scholes model, the Cox constant elasticity of variance model and the Merton jump diffusion model, and to determine the set of input parameters that lead to the most optimal results. The empirical results indicated that on average all of the models are able to estimate the actual rights trading prices relatively well. Some models performed better than others did and these findings were consistent with the original reasonings. The market was shown to not account for the effect of dilution. The best model prices were obtained when calculating volatility over a one year historical period that included the actual rights trading period. The hypothesis regarding trading volume showed that there is a significant impact of trading volume on the estimation of accurate option prices. The filter rule of rejecting rights prices below 10 cents and 100 cents also improved the results thus showing a bias for lower priced rights to be incorrectly valued and possibly some inefficiency in this sector of the market.
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Bibliography: pages 190-209.

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