Originally trained in economics, Professor Tan Wang has been pursuing research in finance for the past two decades. His academic career path has not been a straight line, from studying ambiguity, to studying the Chinese stock market, to helping to build SAIF. Regarding SAIF as a child born at the good timing, in a favorable geographical location and with support from the people, he has high hopes that SAIF will become one of the world class institutes of financial education and research, responsible for leading Chinese financial research in particular. In this interview, we talk to Special-Term Professor of Finance at Shanghai Advanced Institute of Finance, Professor Tan Wang.
Transition to Finance and the Study of Ambiguity
How did you become interested in finance? Professor Wang smiled and summarized: interest. In 1978, he was admitted to the Department of Mathematical Economics at Beijing Institute of Economics (now the Information School in the Capital University of Economics and Business). There he studied computer science and mathematics as tools for applications in the economics. However, it was not until he went abroad that he began studying economics in a systematic way. In September 1986, he went to Canada. The knowledge and skills of mathematics and computer science he previously acquired help him to successfully receive a Master’s and then a doctoral degrees in Economics in the University of Toronto, Canada.
In 1992-96, while he was at the University of Waterloo in Canada as an assistant professor of economics, Professor Wang met a renowned professor in finance, Phelim Boyle. The professor piques his interest in finance. Over time, Professor Wang shifted his research interest from economics to finance. “Professor Phelim Boyle, best known for initiating the use of Monte Carlo methods in option pricing, was a true mentor to me.” Professor Boyle encouraged him in his pursuit of his research in finance. “He had a strong interest in finance, and was kind and generous to me. He encouraged me and gave me the opportunity to teach a few courses in finance. In the process of teaching, I became interested in finance.”
“He was fascinated by the research in real options at the time. So he talked to me a lot about real options. I listened to his questions. Gradually I started to understand the issues and become interested in them. I wrote my first finance paper on real options. That is how I shifted into finance. Very simple. ” says Professor Wang.
While Professor Wang started his transition from economics to finance at University of Waterloo, he did not truly embark on his career in financial research and education until after he moved to the University of British Columbia in Canada. His success did not happen overnight. It took many years. “It has been about 16 years since I started working at the University of British Columbia. It took me about six or seven years of learning and thinking about finance, including doing them mechanically sometimes, to get to know some of the central issues in finance.” he says, being modest about his achievements.
In the past twenty years, Professor Wang’s research focuses mostly on asset pricing under uncertainty. “There are two types of uncertainty. One type is the one where the probabilities of future events can be calculated reasonably accurately, such as the probability that a person would suffer from a particular disease at certain age. The other type is one where the probabilities cannot be calculated with high accuracy. For instance, no one knows the true probability of a financial crisis. This second type of uncertainty is called ambiguity. The research on such problems has generated some new insights in finance,” Professor Wang explains in simple terms.
Professor Wang tells us that the work by David Schmeidler and Itzhak Gilboa and the guidance of his supervisor Larry Epstein were instrumental and inspiring for his own research. The distinction between the two types of uncertainty was first clearly expounded by Frank Knight in his book Risk, Uncertainty and Profit published in 1921. However, no mathematical models were developed that could distinguish between the two types of uncertainty until around 1989 when they were developed in series of works by David Schemdler and Itzhak Gilboa, including their joint work, Maxmin Expected Utility with Non-Unique Prior. In his research, Professor Wang applied their mathematical model to finance and studied equilibrium asset pricing and portfolio choice theory under ambiguity, including the study of the well documented home bias and limited participation phenomena.
Professor Wang explains, “there is a well documented phenomenon called home bias, that is, most people tend to invest in their own home countries. People in rich countries like the United States invest most of their money in their own countries. 95 percent of money in Japan is also invested domestically. Since economic systems in these two countries are similar, why wouldn’t the Japanese invest in the United States, especially during the difficult times in Japan? There were not many people in the US who invested in Japan when the Japanese economy performed well either. One of the explanations provided is based on the application of ambiguity theory. People know much about their own country and little about other countries. Moreover the knowledge is often difficult to quantify in terms of probabilities. As a result, people may want to avoid investment outside their own countries in order to reduce the exposure to such ambiguity.”
Understanding the institutions and Understanding the Chinese Financial Markets
In April 2005, China’s capital market officially launched the Split Share Structure Reform. It was a fundamental transform of the Chinese stock market. Its aim was to convert the existing non-tradable shares, including state-owned and other forms of non-tradable shares, into tradable shares. The co-existence of tradable and non-tradable shares of the same company is a unique phenomenon of the Chinese stock market that had become known as the split share structure of the Chinese stock market. Professor Wang and his co-authors were curious about the factors that affected conversion of the non-tradable shares to tradable shares and together they published a paper on that. “What we examined is really very specific. We would like to know what the factors were that affected the compensation ratio in the conversion.”
Professor Wang explains, “We know a similar situation in the stock markets in North Americas. When a company lists its shares on a public exchange, a significant portion is kept by the founders, instead of being fully circulated in the market immediately. These shares are illiquid of because of that. However, these non-circulating shares that are in the hand of the founders can be traded on the market at any time the founders want. When they are, especially in large quantities, the liquidity in the market would experience changes. At the beginning, we related the tradability issue to liquidity issue. We thought of the non-tradability of the non-tradable shares as a liquidity problem in Chinese stock market. However, later, we realized that there was a fundamental difference. In the United States, those shares held by the founders could be traded from the very beginning, yet they were not circulated just because founders did not want to, while in Chinese capital market at that time, the circulation was simply not allowed.”
“At that point, we realized that when it comes to Chinese stock market, liquidity would not necessarily be the best approach to explaining the problem. We have to develop a new model. Given China’s historical background and the current financial institutions, we believed that it was the Chinese government’s decision to make those non-tradable shares tradable. Once that decision is made, the compensation ratio can and should be determined according to the principles of finance. In fact, such decisions including determination of the compensation ratio could be regarded as a government decision. Based on that view, we built a model,” Professor Wang explained. The paper was successfully published in the Review of Financial Studies.
Many people say that stock market is a barometer of the national economy. However, it seems that the Chinese stock market fails to explain the performance of the Chinese economy in recent years. Facing China’s remarkable economic growth against the backdrop of a global economic slowdown and the embarrassing situation where the Chinese stock market is ranked the last one in the world in terms of performance, a lot of people blame the malfunction of the Chinese stock market. In this regard, Professor Wang points out that as a matter of fact, economic principles are universally true. The Chinese market is not really malfunctioning; rather, it performs according to the institutional environment and the rules of the game. “If you really want to understand Chinese economy, you will need to learn more about the institutions through the lens of these seemingly distorted phenomena. If you understand the connection between the institutions and the phenomena, then you have a true understanding of the Chinese economy.”
The current economic downturn around the world presents a challenge to the Chinese economy. The Chinese economy is going through a crucial period, poised for fundamental financial reform. Like many experts and scholars, Professor Wang is also paying close attention to the market changes and potential risks. “The thing I care about most is the reform of China’s financial institutions. Currently, in China, there are the central bank, commercial banks, policy banks, brokers, insurance companies, and trust companies and so on, all of which are results of the special institutional environment and historical background of China. Given the nation’s historical background, how should these financial institutions evolve? How to make adjustments? How to adapt to the market mechanism? All these are all worth studying,” he believes.
Professor Wang says, he is currently interested in the study of shadow banking in China, and hoping to have some understanding on questions such as where China’s shadow banking is, what exactly its risk management mechanism is, and so on. He emphasizes that the current financial system of the United States is also shaped by its own institutional environment and historical background. Therefore, China’s financial reform should not just copy others mechanically; rather, it is particularly important to enhance our own mechanisms.
High hopes for SAIF
In his leisure time, Professor Wang enjoys travelling, not only exploring the nature, but also experiencing the life in each different society. He would like to stay for a while every time he visits a new place in order to know the local culture as well as how people think and live there. “It was interesting to interact with people from all walks of life. It has broadened my horizon, and inspired different perspectives of thinking,” he says.
As a Special-Term Professor of Finance and a founder of SAIF, Professor Wang spends most of his time at SAIF on teaching, doing research and management duties. He has witnessed its growth in the past three years. In his view, SAIF was born at the right time, favorable geographical location and has support from the right people, “just like a child born at an interesting time, and growing up in a good family, SAIF was born against the backdrop of Shanghai’s continued growth as an international financial center. Institutes like SAIF are necessary for the development of Chinese economy. Thus, I have high hopes for SAIF that he be not just an ordinary child, but rather, one that will contribute to the prosperity of Shanghai and China,” he says.
Professor Wang expresses his expectations that SAIF will become a world-class institute of financial education and research, being a leader in China financial research, and conducting fundamental research on Chinese financial institutions. Also, by providing advanced financial knowledge of both domestic and international, with characteristic talent-cultivating patterns and curriculum of an international vision, SAIF can attract excellent students from home and abroad, and cultivate the most talented finance professionals.