<abstract> <p>A warrant is a financial agreement that gives the right but not the responsibility, to buy or sell a security at a specific price prior to expiration. Many researchers inadvertently utilize call option pricing models to price equity warrants, such as the Black Scholes model which had been found to hold many shortcomings. This paper investigates the pricing of equity warrants under a hybrid model of Heston stochastic volatility together with stochastic interest rates from Cox-Ingersoll-Ross model. This work contributes to exploration of the combined effects of stochastic volatility and stochastic interest rates on pricing equity warrants which fills the gap in the current literature. Analytical pricing formulas for hybrid equity warrants are firstly derived using partial differential equation approaches. Further, to implement the pricing formula to realistic contexts, a calibration procedure is performed using local optimization method to estimate all parameters involved. We then conducted an empirical application of our pricing formula, the Black Scholes model, and the Noreen Wolfson model against the real market data. The comparison between these models is presented along with the investigation of the models' accuracy using statistical error measurements. The outcomes revealed that our proposed model gives the best performance which highlights the crucial elements of both stochastic volatility and stochastic interest rates in valuation of equity warrants. We also examine the warrants' moneyness and found that 96.875% of the warrants are in-the-money which gives positive returns to investors. Thus, it is beneficial for warrant holders concerned in purchasing warrants to elect the best warrant with the most profitable and more benefits at a future date.</p> </abstract>

Prior studies revealed that most researchers tend to employ the Black Scholes model to price equity warrants. However, the Black Scholes model was found deficient by contributing to large estimation errors and mispricing of equity warrants. Therefore, issues involving equity warrants are discussed in this paper, by focusing on specific topics and respective stochastic models to provide a basis for improvements in future research. In recent years, stochastic approaches have been used to a great extent among researchers due to the expansive applications in both theoretical and practical sense. Subsequently, this paper provides the results of a comprehensive literature review on various stochastic modelling methods and its applications for pricing financial derivatives in terms of applications, modifications of methods, comparisons with other methods, and general related researches. Focus is given on two types of stochastic models namely stochastic volatility and stochastic interest rate models, along with the discussions associating these two types of models. This paper acts as a valuable source of information for academic researchers and practitioners not only for pricing financial instruments, but also in various other fields involving stochastic techniques.