Evaluation of the Prices of Shariah-Compliant Company

Warrants in Liquid and Illiquid Markets by Using Modified

Black-Scholes Model
Syarifah Ezzah Solehah Binti Syed Hamid1, a) and Rashidah Ismail1, b)
1
Faculty of Computer and Mathematical Sciences, Universiti Teknologi MARA, 40450 Shah Alam,
Selangor Darul Ehsan, Malaysia
a)
syarifahezzah93@gmail.com
b)
shidah@tmsk.uitm.edu.my

Abstract. The purpose of this study was to determine whether the warrant prices of Shariah-compliant companies
differed much in illiquid market as compared to liquid market at a certain date. Ten Shariah-compliant company warrants
listed under Bursa Malaysia were selected from the lists provided by Securities Commission of Malaysia (SCM) for five
years from August 2011 to August 2016. The stock prices of the warrants selected were evaluated using stochastic supply
curve under both liquid and illiquid conditions. Simple linear regression was applied to obtain significant estimated
liquidity parameter for the supply curve. The estimated liquidity parameter obtained was then used to evaluate the stock
prices in illiquid market. The stock prices for a liquid market were calculated by taking the liquidity parameter to be 0.
The evaluated stock prices and calculated expected return as average returns of stocks were inserted into Ukhov’s Black
Scholes model with dilution effect to evaluate warrant prices in both illiquid and liquid markets. This study found that the
differences between the evaluated warrant prices in illiquid and liquid markets were very small. This implies that the
evaluated warrant prices between the two markets seemed not to have much difference. This gives strong indication that
illiquid market does not affect much the warrant prices of the Shariah-compliant companies listed in Bursa Malaysia. We
hope this study will convince investors to consider Shariah-compliant company warrants as their choice in investments
since their prices do not differ much during good or bad economic conditions.

Keywords: Black Scholes model, company warrant, dilution effect, illiquid market, Shariah-compliant

INTRODUCTION
Investment in stock market is a common activity to earn profit in any country including Malaysia. Bursa
Malaysia has two sides in a stock market which are conventional and Shariah-compliant. Companies in Bursa
Malaysia need to undergo the Screening Methodology proposed by the Shariah Advisory Council (SAC) of the
Securities Commission of Malaysia (SCM) in order to pass the Shariah-compliant [1] status. Option trading is
common in stock market. However, it is replaced with warrant in Bursa Malaysia since option is prohibited in
Shariah [2] and warrant is similar to a long-term call option issued by a company on its own equity [3]. This study
was focused only on company warrants in Bursa Malaysia as they are considered as Shariah-compliant as long as
the underlying stock (the shares of the issuer) is Shariah-compliant [4]. Company (equity) warrant is issued by the
company itself and gives the holder the right, but not an obligation, to subscribe for new ordinary shares at a
specified price during a specified period of time [1].
Fine liquidity level of the stock market is an obligation that needs to be fulfilled and maintained for the sake of
good investment performance. Liquidity can be defined in financial market as the degree of transaction of a security
or asset that will not significantly affect its price [5]. A market with poor liquidity is known as illiquid market. [6]
stated that a liquid market is exhibited with low transaction cost (tightness), quick order execution and efficiency of
the transaction system (immediacy), plenty existing orders either as real or easily discovered potential buyers and
sellers, with both having limitation based on the current price of the security trades (depth), small price impact from
orders that are large in both volume and quantity (breadth) and quick flow of new orders to correct order imbalances
that tend to shift away fundamental-guaranteed prices (resiliency). For simpler identification, liquid markets main
characteristics are stated with high levels of daily transactions and low price impact, while illiquid markets are
characterised with large daily fluctuations in price and low levels of daily transactions [7].
Misconception on Shariah-compliant financial products and high associated transaction costs are common
problems that lead to market illiquidity. Regardless of the market conditions, company warrants already have a
disadvantage known as dilution effect during its exercise. Dilution effect is the depreciation in value of share price
due to the increasing number of outstanding shares in the company caused by delivery of new shares to warrant
holders during the warrants exercise [2]. The warrant prices can be affected by the liquidity state of the stock market
as it is essential to smoothen any transaction. If fewer warrants are exercised in a company in illiquid market, then a
lesser number of shares are being delivered and issued by the company. Hence, it is possible that the value of the
warrant price will not be further depreciated in illiquid market due to the dilution effect.

BLACK SCHOLES MODEL WITH DILUTION EFFECT

Evaluation on warrant can be done using Black Scholes model as both are similar in terms of function. Equation
(1) below is the basic Black-Scholes equation where it is a linear parabolic partial differential equation (PDE) [3]:

𝑑𝑉 1 𝑑2 𝑉 𝑑𝑉
𝑑𝑡
+ 2 𝜎 2 𝑆 2 𝑑𝑆 2 − 𝑟𝑉 + 𝑟𝑆 𝑑𝑆 = 0. (1)

The inputs in (1) are asset price (𝑆), time (𝑡), option or warrant value of an underlying asset at a time (𝑉(𝑆, 𝑡)),
volatility rate (𝜎), drift rate or expected return (𝜇) and risk-free interest rate (r). The expected return (𝜇) is the
growth rate of the underlying asset and volatility rate (σ) is the measure on the expected movement of the stock
price. In addition, the 𝑉(𝑆, 𝑡) can be replaced with other symbols according to the type of the options such that:
𝐶(𝑆, 𝑡) is value of call option, while 𝑃(𝑆, 𝑡) is value of put option. [8] mentioned and compared four studies that
incorporated dilution effect into Black Scholes model for better warrant evaluation and so far the fourth study by [9]
is regarded as the most appropriate model for diluted warrant evaluation due to the model incorporating observed
value of firm’s asset (𝑉 ∗ ) and volatility of a firm (𝜎 ∗ ), hence it was used in this study. The Black-Scholes Model
modified by [9] is as below:

1. To numerically solve the following system of non-linear equations for (𝑉 ∗ , 𝜎 ∗ ):

𝑁𝑆 = 𝑉 − [𝑛𝑊(𝑘𝑉, 𝑇 − 𝑡, 𝐾, 𝜎, 𝑟, 𝑘, 𝑁, 𝑛)].
{ 𝜎𝑉 𝜎𝑉 (1−𝑛)∆𝑤 𝜎𝑉 𝑁+𝑘𝑛−𝑛𝑘𝛷(𝑑1 ) (2)
𝜎𝑆 = ∆𝑠 = ( )= ( ).
𝑆 𝑆 𝑁 𝑆 𝑁(𝑁+𝑘𝑛)

2. The evaluated warrant price (𝑤) is calculated as below:

𝑉 ∗ −𝑁𝑆
𝑤= 𝑛
. (3)

The warrant value (𝑊) in (2) is calculated by using modified call option formula shown in (4) until (6) as below.
Note that 𝛷(. ) in (2), and (4) represent the cumulative normal distribution function [3].
1
𝑊= [𝑘𝑉𝛷(𝑑1 ) − 𝐾𝑁𝑒 −𝑟(𝑇−𝑡) 𝛷(𝑑2 )]. (4)
𝑁+𝑘𝑛

1 𝑘𝑉 𝜎2
𝑑1 = [𝑙𝑛 ( ) + (𝑟 + )(𝑇 − 𝑡)]. (5)
𝜎√(𝑇−𝑡) 𝑁𝐾 2

𝑑2 = 𝑑1 − 𝜎√(𝑇 − 𝑡). (6)

 The inputs for the model above are classified such that: 𝑊 is warrant value; 𝑉 is company’s asset value; 𝑁 is
number of outstanding shares in a company; 𝑛 is number of issued warrants in a company; 𝑘 is conversion ratio
from warrant to share during exercise; 𝑆 is stock price; 𝐾 is warrant exercise price; (𝑇 − 𝑡) is remaining warrant
time period to expiration date (years); 𝜎𝑆 is volatility rate of a company’s stock (%); 𝑟 is risk-free interest rate (%);
∆𝑠 is measure of money price changes in stock’s share when company’s value changes by one unit of money price;
and ∆𝑤 is measure of money price changes in warrant price when company’s value changes by one unit of money
price.

STOCHASTIC SUPPLY CURVE

The warrant evaluation from [9]’s model assumed perfect liquid market as one of the basic assumptions in Black
Scholes model [3; 10]. Warrant evaluation in illiquid market at a certain date in this study was done by inserting
illiquid stock price of the respective date into [9]’s model. The illiquid stock price required was evaluated using
stochastic supply curve proposed by [11] that was later extended to Black Scholes economy by [12] with simple
exponential formula such as below:

𝑆(𝑡, 𝑥) = 𝑒 𝛼𝑥 𝑆(𝑡, 0), 𝛼 > 0. (7)

with the marginal stock price that follows Geometric Brownian motion,

𝑠0 𝑒 𝜇𝑡+𝜎𝐵𝑡
𝑆(𝑡, 0) ≡ . (8)
𝑒 𝑟𝑠 𝑡

where 𝛼 is liquidity parameter (lots) is, 𝑥 is transaction size in lots, 𝑠0 is initial stock price, 𝜇 is expected return (%),
𝑟𝑠 is spot interest rate, and 𝐵𝑡 is standard Brownian motion initialized at zero. This curve also allows stock price
evaluation in perfect liquid market by simply let 𝛼 = 0 [12]. This stochastic supply curve was chosen for this study
for its simplicity and the curve let security’s price acts as a function of trade size as an effect of transaction costs
[12]. The trade size factor in the curve was compatible for warrant evaluation as it was based on the dilution effect
caused by the increasing number of shares. Furthermore, transaction cost is one of many factors that bring illiquidity
in financial market and this cost for Shariah-compliant product is much higher since the product is credence goods
(unverified quality even after purchase) and highly specific asset [13]. The value of liquidity parameter (𝛼) and
expected return (𝜇) in (7) and (8) respectively were estimated using simple regression on a certain regression
equation [12]. Further details on simple regression are explained later in this study.

DATA SELECTION AND COLLECTION

Both models by [9] and [12] needed two similar inputs which are interest rate and volatility rate. However, [12]
used spot interest rate (𝑟𝑠 ), instead of risk-free interest rate (𝑟) in their study. These two interest rates are not the
same by definition since the former is defined as a short-term interest rate that depends on time [3]. This study
followed one of the Black-Scholes assumptions where the interest rate is risk-free and constant [3; 10], therefore, the
spot interest rate (𝑟𝑠 ) in [12]’s model was replaced as 𝑟. The value of 𝑟 for this study was based on the 3-Month
Kuala Lumpur Islamic Reference Rate (KLIRR) from [14] and was continuously compounded [9] such that:
𝑟 = 𝑙𝑛(1 + 𝐾𝐿𝐼𝑅𝑅). The volatility rate (𝜎) in (8) was assumed to be constant [9; 10; 12] and synonymous with
stock volatility rate (𝜎𝑆 ) in [9]’s model for this study. The stock volatility rate (𝜎𝑆 ) then was computed based on the
return pattern of a firm’s stock closing prices (S) [3] by using equation (9) and (10) below:

∑𝑀 ̅ 2
𝑖=1(𝑅𝑖 −𝑅 )
𝜎𝑆 = √ (𝑀−1) 𝛿𝑡
(9)

where M is the total number of days in the close price data set, 𝛿𝑡 = 1/𝑑, where 𝑑 is 252 trading days in a year, 𝑅̅ is
mean of return (R) and the return from day i to day (i+1) is
𝑆𝑖+1 −𝑆𝑖
𝑅𝑖 = , 𝑆𝑖 ≠ 0. (10)
𝑆𝑖
 The stock close price (𝑆) and volume (𝑥) data set of each company in daily manner were collected for the
volatility rate computation above and as inputs for by [9]’s and [12]’s models. The data set was also required for
estimating the liquidity parameter (𝛼) and expected return (𝜇) in (7) and (8), respectively through regression [12] for
the stock price evaluation in illiquid market case. The time-series data for this study were collected from [15]’s
website based on the proposed criteria below:

(a) Ten companies in Bursa Malaysia confirmed as Shariah-compliant for the last 5 years (August 2011 to
August 2016) from the Shariah-compliant securities’ lists provided by [16].
(b) Each selected company had one active company warrant in the market that was listed at least from 2013 and
expiring somewhere in 2017 and later [17].
(c) Excluded any Shariah-compliant companies listed under the latest [1]’s Practice Note 17/2005 (PN17) as the
listed companies were already considered financially troubled [18].
(d) The liquidity parameter (𝛼) of a company must be more than zero after being estimated from regression
[12].
(e) 5-year duration from 1st August 2011 to 31st August 2016 for daily close price and volume data sets of each
company collected from [15]’s website.

There were more than 600 Shariah-compliant companies in each year of the 5-year duration in condition (a) [16],
but only ten companies were selected for this study as each company’s close price and volume data in the 5-year
duration was large (more than 1200 data) and most companies in Bursa Malaysia did not pass condition (a), (b) and
(d) during this study’s analysis. Furthermore, too much time was required to verify each company to pass each
proposed condition above. Condition (c) was proposed to follow the liquid market assumption [9] for the stock close
price data in each selected company in Bursa Malaysia. Only by evaluating the stock price in [12]’s supply curve
using the required inputs that the stock price was considered as illiquid for this study. Major inputs needed for [9]’s
model for company warrant evaluation beside stock price (𝑆), stock volatility rate (𝜎𝑆 ) and risk-free interest rate (𝑟),
were obtained from the respective company’s annual report on 2016 and [17]’s websites.

BASIC CONCEPT OF SIMPLE LINEAR REGRESSION

The information in this section was entirely referred to from [19]. Basic simple regression is the usual two-
variable regression where one dependent variable is related to one independent variable and the relationship is
commonly expressed in linear manner. Let 𝑦 as dependent variable and ℎ as independent variable for this section.
Regression can be presented as a population regression function (PRF) for each observation in data sample such as
follows

𝑦𝑗 = 𝑏1 + 𝑏2 ℎ𝑗 + 𝜀𝑗 . (11)

where 𝑏1 and 𝑏2 are unknown but fixed regression coefficients, 𝑗 is the observation number in data sample; and 𝜀𝑗 is
jth error term. The PRF in (11) is considered as not directly observable, hence (11) can be estimated through
regression as a sample regression function (SRF) in stochastic form as below:

𝑦𝑗 = 𝑏̂1 + ̂
𝑏2 ℎ𝑗 + 𝜀̂.
𝑗 (12)

The values and coefficients in (12) labelled with cap symbol (^) are read as ‘estimated’ of the respective value. The
overall regression process is to estimate PRF in (11) as SRF in (12) on the basis of observations on 𝑦 and ℎ data
sample, to find the unknown regression coefficients (𝑏̂1 and 𝑏 ̂2 ). The estimation of 𝑏̂1 and 𝑏 ̂2 are commonly
computed using Ordinary Least Square (OLS) method by minimizing the sum square of errors (∑ 𝜀̂𝑗2 ) from (12) as
zero. The regression also undergoes a number of validation tests for the accuracy of the estimated coefficients. This
study only used three validation tests, which were Probability Value (p-value) Test, Confidence Interval (CI) for
estimated parameters and Residual Graphical Plot with Durbin-Watson Test, which are explained in detail under the
sub-section below.
 ESTIMATING LIQUIDITY PARAMETER (𝜶) AND EXPECTED RETURN (𝝁)
The value of liquidity parameter (𝛼) and expected return (𝜇) in (7) and (8) respectively was estimated using
simple regression on (13) below [12]:

𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 )
𝐼𝑛 ( ) = 𝛼(𝑥𝜏𝑖+1 − 𝑥𝜏𝑖 ) + 𝜇(𝜏𝑖+1 − 𝜏𝑖 ) + 𝜎𝜀√𝜏𝑖+1 − 𝜏𝑖 . (13)
𝑆(𝜏𝑖 ,𝑥𝜏 )
𝑖

where 𝜏𝑖 is time index corresponding with order flow 𝑥𝜏𝑖 ; 𝑥𝜏𝑖 is transaction size at 𝜏𝑖 ; 𝑆(𝜏𝑖 , 𝑥𝜏𝑖 ) is stock price for
every transaction 𝑖 = 1,…𝑁 in a given day and 𝜀 is the error term being distributed under standard normal
distribution (N (0, 1)). [12] used [20]’s algorithm to specify the trade size (𝑥) from 5 to 10 lots (5 ≤ 𝑖 ≤ 10) and
labelled as either buy or sell, based on the bid and ask prices in 5-second time interval for both current and prior
quotation (price movement). Such labelling was nearly impossible for this study as bid and ask prices quotation data
were almost unavailable. Therefore, the simple regression method on (18) was applied instead by using daily stock
close price of a company where 𝑖 is referred to as the number of day instead of number of transactions in a day and
𝑑𝑎𝑦 𝑖(𝑡ℎ)
𝜏𝑖 = = 1/252 in increment size where 𝑑 is number of trading days in a year [3]. The size order was also
𝑑
not specified in this study and referred to as the volume in shares corresponded with the stock close price at a certain
day. The trade size or number of shares (volume) of a stock in Malaysia’s stock market is measured as lot which is
equivalent to 100 shares and is a normal liquidity measure.

Modify Regression Model (13)

Several modifications were made on (17) for this study with the aim to convert it as a simple linear regression
(PRF) such as (11) above where the error term (𝜀) being singular on the right hand side (RHS) of (13) for better
calculation implementation in Microsoft Excel. The modifications are shown below:

(i) Symbolize the difference components at the RHS with new respective independent variables such that:
𝑋𝑗 = 𝑥𝜏𝑖+1 − 𝑥𝜏𝑖 ; and 𝐷𝑗 = 𝜏𝑖+1 − 𝜏𝑖 :

𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 )
𝐼𝑛 ( ) = 𝛼(𝑥𝜏𝑖+1 − 𝑥𝜏𝑖 ) + 𝜇(𝜏𝑖+1 − 𝜏𝑖 ) + 𝜎𝜀√𝜏𝑖+1 − 𝜏𝑖 . (13)
𝑆(𝜏𝑖 ,𝑥𝜏𝑖 )
𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 )
𝐼𝑛 ( ) = 𝛼𝑋𝑗 + 𝜇D𝑗 + 𝜎𝜀𝑗 √D𝑗 .
𝑆(𝜏𝑖 ,𝑥𝜏𝑖 )

(ii) Singularize the error term (𝜀𝑗 ) on RHS by dividing both left hand side (LHS) and RHS with 𝜎√D𝑗 :

1 𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 ) 𝛼 𝜇
[𝐼𝑛 ( )] = 𝑋𝑗 + D𝑗 + 𝜀𝑗 , 𝜎 ≠ 0, D𝑗 ≠ 0.
𝜎 √𝐷𝑗 𝑆(𝜏𝑖 ,𝑥𝜏𝑖 ) 𝜎 √D𝑗 𝜎 √D𝑗

(iii) At RHS: Simplify the independent variables (𝑋𝑗 and 𝐷𝑗 ), and arrange every component in its place in
accordance to parameters (regression coefficients) and independent variables, such as (11) above:

1 𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 ) 𝛼 𝑋𝑗 𝜇
[𝐼𝑛 ( )] = ( ) + √D𝑗 + 𝜀𝑗 .
𝜎 √𝐷 𝑗 𝑆(𝜏𝑖 ,𝑥𝜏𝑖 ) 𝜎 √D𝑗 𝜎

1 𝑆(𝜏𝑖+1 ,𝑥𝜏𝑖+1 )
(iv) Symbolize the whole LHS as a single dependent variable such that 𝑌𝑗 = [𝐼𝑛 ( )]:
𝜎 √ D𝑗 𝑆(𝜏𝑖 ,𝑥𝜏𝑖 )

𝛼 𝑋𝑗 𝜇
𝑌𝑗 = ( ) + √D𝑗 + 𝜀𝑗 .
𝜎 √ D𝑗 𝜎
 (v) Simplify further the RHS by new symbols such that: 𝛽1 = (𝛼/𝜎); 𝛽2 = (𝜇/𝜎); 𝐸𝑗 = (𝑋𝑗 /√D𝑗 ); and
𝐹𝑗 = √D𝑗 :

𝑌𝑗 = 𝛽1 𝐸𝑗 + 𝛽2 𝐹𝑗 + 𝜀𝑗 . (14)

The variables from step (i) to (v) above can be defined such that: 𝑋𝑗 is the difference in number of shares (lots)
traded from day 𝑖 to day (𝑖 + 1) in increment size 𝜏 (unit); 𝐷𝑗 is the timeline difference in increment size 𝜏 (unit), 𝐹𝑗
is the square root of 𝐷𝑗 (unit); 𝐸𝑗 is the unit value calculated from 𝑋𝑗 (lots) divided by √𝐷𝑗 ; 𝑌𝑗 is the unit value
calculated from daily logarithmic return (%) divided by volatility rate (%) multiplied with 𝐷𝑗 ; 𝛽1 is a regression
coefficient representing variable 𝐸𝑗 where its unit value is calculated by dividing the liquidity parameter (lots) with
volatility rate (%); and 𝛽2 is a regression coefficient representing variable 𝐹𝑗 when its unit value is calculated by
dividing the expected return (%) with volatility rate (%). Hence, the estimated equation (SRF) of (14) for regression
is

̂1 𝐸𝑗 + 𝛽
𝑌𝑗 = 𝛽 ̂2 𝐹𝑗 + 𝜀̂𝑗 (15)

The estimated values of regression coefficient (𝛽̂1 and 𝛽

̂2 ) of (15) above through OLS than were used to derive the
value of estimated liquidity parameter (𝛼̂) and estimated expected return (𝜇̂ ) by using the same equations
representing the coefficients in step (v) above such that: ̂
𝛽1 = 𝛼̂/𝜎̂ → 𝛼̂ = 𝛽̂1 𝜎̂, and 𝛽
̂2 = 𝜇̂ /𝜎̂ → 𝜇̂ = 𝛽
̂1 𝜎̂. Three
validation tests were done on the results of regression analysis on equation (19) for better justification on the
evaluated 𝛼 and 𝜇. The three tests are explained below:

Probability Value (p-value)

The p-value test represents the lowest significance level to reject the null hypothesis [19]. The hypotheses for the
p-value test at a set significant level [21], where 𝑞 is a number representing the respective estimated regression
coefficient number (𝛽̂ ), are indicated below:

𝐻0 (Null Hypothesis) : 𝛽𝑞 = 0, for q = 1, 2, …

𝐻1 (Alternative Hypothesis) : 𝛽𝑞 ≠ 0, for q = 1, 2, …

The significance level chosen for the p-value test in this study was 5% [12] with additional two significance levels
of 1% and 10% for variability analysis. [21] stated that 𝐻0 is rejected if p-value is less than the set significant level,
hence the parameter is significant.

Confidence Interval (CI) for Estimated Parameters

This test usually covers up to 95% where the interval shows the range of values of respective estimated
parameter (𝛽 ̂𝑞 ) to be true in 95 out of 100 cases [19]. The percentage for CI is based on significance level such that
100(1 – significance level)% [19]. Hence, after deducting 1%, 5% [12] and 10% significance levels (in the p-value
test above) from 100, coverage of confidence intervals for this study were each 90%, 95% and 99% respectively.
̂𝑞
The measure for this test was such that: the shorter the CI range, the smaller the uncertainties of the calculated 𝛽
to be true. The formula for CI is

̂𝑞 ± 𝑡𝑠𝑖𝑔𝑛𝑖𝑓𝑖𝑐𝑎𝑛𝑐𝑒 𝑙𝑒𝑣𝑒𝑙/2 ∗ 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑒𝑟𝑟𝑜𝑟 (𝛽

𝛽 ̂𝑞 ). (16)

However, if a parameter is insignificant than its p-value, then its CI range shall be ignored as insignificant parameter
is irrelevant in the regression regardless of its CI size.
 Residual Graphical Plot with Durbin-Watson Test
This third test was to detect serial correlation. Serial correlation is error term in a corresponding period which is
related to other error terms at different periods and its existence is considered a violation to one of the important
assumptions of econometric estimation [21]. According to [19], the graphical method shows autocorrelation
presence when the residual plot is behaving in either seasonal, cyclic or trend pattern. The trend pattern can be either
positive or negative. In addition, the preferable graph plot to avoid autocorrelation is when the residual pattern is
random against the timeline of the regression. As such, the Durbin-Watson test was another test done to validate the
graphical method in this study. The Durbin-Watson test taken from [19] was to detect first-order autocorrelation and
its formula is

∑𝑡=𝑀 ̂ 𝑗 −𝜀̂𝑗−1 )2
𝑡=2 (𝜀
𝐷= ∑𝑡=𝑀 ̂ 𝑗2
, 0 ≤ 𝐷 ≤ 4. (17)
𝑡=1 𝜀

where 𝜀̂𝑗 is jth estimated error value. The best value to avoid autocorrelation in a data sample is when the value of
Durbin-Watson test, D is nearest to two. The autocorrelation can be either positive or negative according to the D
value detected. The closer D value to 0 indicates greater evidence of positive autocorrelation, while closer D value
to 4 shows more proof on negative autocorrelation [19].

REMODEL REGRESSION MODEL (14) FOR SECOND REGRESSION

The results from [12]’s study stated that the estimated liquidity parameter (𝛼̂) was almost positively significant,
while the estimated expected return (𝜇̂ ) was insignificant at 5% level. This study’s regression on (14) also had
similar results but was instead shown on every chosen significance level in the p-value test above. The 𝜇 parameter
along with 𝐹𝑗 variable thus was removed from (14) as a new regression formula (18) below to follow parsimony
(simpler) concept [21]:

𝑌𝑗 = 𝛽1 𝐸𝑗 + 𝜀𝑗 . (18)

Another regression and three similar validation tests were simulated for the new equation above in its estimated
form as below:

̂1 𝐸𝑗 + 𝜀̂𝑗
𝑌𝑗 = 𝛽 (19)

and any company with both insignificant parameters and had negative value for estimated liquidity parameter (𝛼̂)
was replaced by another company and the same process was repeated. The value of 𝛼̂ in the second regression was
computed using the same modified formula for 𝛽 ̂1 calculation in the first regression mentioned in step (v) above:
̂1 𝜎̂. The expected return (𝜇) parameter from the removed 𝛽2 in (14) however was a necessary input for both
𝛼̂ = 𝛽
[12]’s and [9]’s models. Therefore, the expected return (𝜇) was determined instead as the average returns of the asset
[3] such that

∑𝑛
𝑖=1 𝑅𝑖
𝜇= . (20)
𝑀𝛿𝑡

with assumption that 𝛿𝑡 = 1/𝑑 = 1/252 trading days. The estimated liquidity parameter (𝛼̂) obtained from the
second regression was used as one input for stock price evaluation in illiquid market case, while zero-value liquidity
parameter (𝛼 = 0) was used for stock price evaluation in liquid market case [12] in this study. The expected return
(𝜇) calculated from (20) was used as the other input necessary for stock price evaluation in [12]’s model (Equation
(7) and (8)) for both illiquid and liquid market cases. The stock prices of both market cases were evaluated on t =
30/8/2016 as it was the latest date in the data sample for each company. These illiquid and liquid stock prices then
were inserted into the [9]’s model (Equation (2) - (6)) to evaluate the company warrant prices (𝑊 ∗ ) in respective
∗
market. The difference values between the evaluated warrant prices in liquid market (𝑊𝐿𝐼𝑄 ) and the evaluated
∗
warrant prices in illiquid market (𝑊𝐼𝐿𝐿𝐼𝑄 ) was simply measured using subtraction.
 RESULTS AND DISCUSSION
TABLE 1. List of selected Shariah-compliant company warrants with their prices evaluated in both markets and the difference
between the prices
Company name Company warrant 𝑾∗𝑳𝑰𝑸 - RM 𝑾∗𝑰𝑳𝑳𝑰𝑸 - RM Difference in prices – RM
APFT Bhd (APFT) APFT-WA 0.0777 0.0777 0.0000
Fitters Diversified Bhd (FITTERS) FITTERS-WB 0.1608 0.1606 (-0.0002)
Harbour-Link Group Bhd (HARBOUR) HARBOUR-WC 0.8107 0.8022 (-0.0085)
Kelington Group Bhd (KGB) KGB-WA 0.9087 0.9086 (-0.0001)
Taliworks Corporation Bhd (TALIWRK) TALIWRK-WB 0.5807 0.5777 (-0.0030)
Kumpulan Jetson Bhd (JETSON) JETSON-WB 0.5202 0.5202 0.0000
DPS Resources Bhd (DPS) DPS-WB 0.3167 0.3164 (-0.0003)
Ho Hup Construction Company Bhd (HOHUP) HOHUP-WA 1.2249 1.2241 (-0.0008)
Dominant Enterprise Bhd (DOMINAN) DOMINAN-WA 0.3200 0.3200 0.0000
Ire-Tex Corporation Bhd (IRETEX) IRETEX-WA 0.1489 0.1489 0.0000

APFT (D = 2.283) 𝑆(𝑡, 0) : Liquid stock prices

𝑆(𝑡, 𝑥) : Illiquid stock prices
(a) (b)
FIGURE 1. APFT’s results from (a) Durbin-Watson test with residual graph, and (b) [12]’s stochastic supply curve plotlines.
Note: The results in (a) and (b) for the other nine companies are shown in the same manner as APFT.

The p-value test on the first simple regression using (14) showed that 𝜇̂ parameter was insignificant compared to
𝛼̂ being significant at each chosen significance levels (1%, 5%, and 10%). The three confidence intervals of 𝛼̂ which
were 90%, 95% and 99% at the respective significance levels were considered satisfactory as each interval was very
small and close to zero. Furthermore, the differences in term of range between the three confidence intervals were
also very small and close to zero. The third validation test however detected negative autocorrelation in every
company excluding FITTERS, despite each company having optimal D value and random pattern in respective
residual plot (Figure 1(a)). The detected autocorrelation was ignored as the negative autocorrelation may only affect
the regression values in small manner and might bring to almost little difference if remedied [19].
Another regression was done using equation (18) since 𝜇̂ was insignificant on the three significance levels from
the first regression p-value test. Overall, the results of the three validation tests on the second regression were still
similar from the first regression in term of 𝛼̂ significance at each chosen significance level, the short range of the
three confidence intervals for 𝛼̂ value, the optimal D values and random residual graph pattern despite the detected
but ignored negative autocorrelation. The values from the three tests on the second regression also improved in very
small and near to zero gaps than from the tests on the first regression. Hence, the second regression model used in
this study may pass in terms of consistency but not in perfect validation. Only the expected return (𝜇) of each
company calculated using (20) had slight improvement by more than 5% to below 40%, than their estimated
expected return (𝜇̂ ) values calculated from the first regression.
Figure 1 (b) showed that the evaluated stock prices in both liquid market (𝑆(𝑡, 0)) and illiquid market (𝑆(𝑡, 𝑥))
for each company seemed to have very tiny differences as the plot lines of the two stock prices were aligned
together and almost looked as one plot. The warrant evaluation method in this study was considered satisfactory as
the fifth column of Table 1 showed that the evaluated warrant prices seemed not to have much difference in any
market condition as the differences were very close to zero. Table 2 also showed that most evaluated warrant prices
∗ ∗
in illiquid market (𝑊𝐼𝐿𝐿𝐼𝑄 ) were significantly smaller than their respective prices evaluated in liquid market(𝑊𝐿𝐼𝑄 ).
This small error result may promote company warrants to be selected as an investment tool by Muslim investors as
their prices so far are not affected by the market’s liquidity condition.

CONCLUSION
The theoretical warrant prices in both liquid and illiquid market were very close in this study. This small
difference results may strongly indicate that the prices of Shariah-compliant company warrants listed from Bursa
Malaysia are not much affected by the illiquid state of the capital market. For future recommendations, more
company warrants should be included as this study excluded certain number of Shariah-compliant companies to
follow the proposed criteria. This study also do not present the overall efficiency of company warrants pricing in
Bursa Malaysia as only ten company warrants were analysed. This study’s field can also be expanded to other global
capital markets. In addition, other stochastic model can be used in this study instead of Brownian motion for further
interesting research and possible outcomes.

ACKNOWLEDGMENT
This research was funded by Institute of Research Management & Innovation (IRMI) of Universiti Teknologi
MARA (UiTM) with project code 600/IRMI/DANA 5/3/LESTARI (0127/2016). Appreciation is extended to family,
friends and colleagues for support rendered in completion of this research.

REFERENCES
1. Bursa Malaysia, retrieved from http://www.bursamalaysia.com/. 2016.
2. Razali H., Journal of Islamic Finance 3(2), 39–48 (2014).
3. P. Wilmott, Paul Wilmott Introduces Quantitative Finance, 2nd ed. (John Wiley & Sons Ltd., Chichester,
2007).
4. Securities Commission Malaysia, Resolutions of the Securities Commission Shariah Advisory Council, 2nd ed.
(Securities Commission, Kuala Lumpur, 2007), pp. 60.
5. L. N. Switzer and A. Picard, Economic Modelling 57, 106-119 (2016).
6. A. Sarr and T. Lybek, IMF Working Papers 02/232 (2002).
7. S. Bogdan, S. Bareša and S. Ivanović, Tourism and Hospitality Management 18(2), 183–193 (2012).
8. W. Xiao and X. Zhang, Physica A: Statistical Mechanics and its Applications 458, 219–238 (2016).
9. A. D. Ukhov, Journal of Financial Research 27(3), 329–339 (2004).
10. S. Ray, Journal of Science 2(4), 172–178 (2012).
11. U. Ҫetin, R. A. Jarrow and P. Protter, Finance and Stochastics 8, 311–341 (2004).
12. U. Ҫetin, R. A. Jarrow, P. Protter and M. Warachka, Review of Financial Studies 19(2), 493–529 (2006).
13. R. Hayat, F. Den Butter & U. Kock, Journal of Business Ethics 117(3), 601-613 (2013).
14. Islamic Interbank Money Market, retrieved from http://iimm.bnm.gov.my/index.php?ch=22. 2016.
15. Wall Street Journal, retrieved from http://www.wsj.com/. 2016.
16. Securities Commission Malaysia, retrieved from http://www.sc.com.my/data-statistics/list-of-shariah-
compliant-securities-by-scs-shariah-advisory-council/. 2011-2016.
17. I3investor, retrieved from http://klse.i3investor.com/. 2016
18. Wan Adibah W. I., Khairul Anuar K. and Siti Rahayu S., Journal of Islamic Accounting and Business Research
6(1), 19–41 (2015).
19. D. N. Gujarati and D. C. Porter, Basic Econometric, 5th ed. (McGraw-Hill/Irwin, New York, 2009).
20. M. C. Lee and M. J. Ready, Journal of Finance 46(2), 733–746 (1991).
21. Mohd Alias L., Introductory Business Forecasting A Practical Approach, 3rd ed. (Universiti Teknologi
MARA Press, Shah Alam, 2011), pp. 180–190.