Warrant Pricing Model with Autocorrelated Underlying Stock Returns

We develop an analytic warrant pricing model with perfect hedging in an inefficient market model where the underlying price variations are autocorrelated. This is accomplished by assuming that the underlying noise in the system is derived by an Ornstein-Uhlenbeck process, rather than from a Wiener process. This model provides a valuable insight into dependence of warrant price on the return autocorrelation. The analytical solution obtained here reduces to the well known Black Scholes option pricing formula for the special case of no autocorrelation in asset returns, and the PerellO and Masoliver model when autocorrelation coefficient is reciprocal of autocorrelation time.