Reinforcing Research with a Focus on the Chinese Financial Markets


In 1991, the first Doctor of Philosophy degree in Applied Physics was granted at the University of Michigan in Ann Arbor to Hong Yan, who is now Professor of Finance at Shanghai Advanced Institute of Finance (SAIF) and Associate Director of China Academy of Financial Research (CAFR), both of Shanghai Jiao Tong University. Three years later, after a stint as a research assistant professor at the University of Washington in Seattle doing research on materials physics, he decided to switch to studying finance and embarked on his career of financial research and education. In this interview, Professor Yan shares with us his working and life experience, touching on aspects of his academic background and research projects and his views on SAIF’s development in the future.

Doing financial research with skills honed in physics, and contributing to China’s development

By 1991, Professor Yan had received his Bachelor's, Master's and Ph.D. degrees in the field of physics, yet three years later he ultimately chose to restart his career in finance. Why did he give up nearly a decade of physics study and start down a new career path? Many of us may be curious about his educational experience. "As undergraduate students in China at that time, we knew very little about business and economics. We used to bear in mind that we would be able to go to any place in the world if we could learn mathematics, physics and chemistry well. It seemed that everyone would study these subjects and try to become a scientist. I was not the exception. " He continues, "it is interesting to learn physics, a subject that explains various natural phenomena and demands logical thinking. However, as one studies physics to a certain extent, the scope of research becomes particularly narrow and too specialized. Publications in this field may be read or understood by only a few people. Its impact on the society is limited."

In early 1990s, China re-launched its economic reform and began to vigorously implement the policy of opening up the economic system. Since China’s rapid economic growth engine was activated, a systematic understanding how economies and markets work has become more important than ever before. Professor Yan recalls, “At that time, I did some investigation in terms of economics and finance. Scientific knowledge and mathematical skills that I obtained by studying physics were transferable. More importantly, economic and financial research is a boon to the development of a country. I knew a number of senior graduate students who then went to study finance or got jobs on Wall Street. By communicating with them, I learned more about finance and found myself intensely interested in it. After that, I decided to go to study finance.”

On the other hand, for Professor Yan his years of research in physics were not at all lost. He says, “Physics is a strongly logical discipline. And logical thinking and mathematical background are immensely helpful for studying finance and understanding its theories.” He continues, “for instance, I did research in statistical physics when I was studying physics. Actually, statistics is very often applied when we do research on financial markets. Although the fundamental concept of finance is grounded in no-arbitrage equilibrium theory, in order to achieve equilibrium in financial markets, there exists a dynamic process. That is the reason why financial markets experience price volatility. Similar dynamic processes are also studied in physics. My prior training enables me to gain better insights into how financial markets work.”

“Interestingly, among research scholars in physics, many of them are now doing research in finance as their main research directions”, says Professor Yan, “they even created a field called Econophysics, which is the study of economic phenomena from the point of view of physics. This illustrates that there are similarities between physics and economics. However, I should emphasize that to understand how markets work, it is important to get the economic intuition right, mathematical techniques are just tools to enable us to unveil better intuitions.”

Enforcing market rules is the only sustainable way to reignite a sluggish A-share market

Professor Yan’s research interests include asset pricing, portfolio and risk management. His papers have been published in the world’s leading academic journals in the field. As for his research on the relationship between corporate decision-making and stock returns, he explains, stock return is one of the most important measures of asset pricing. Asset pricing theories used to focus on market-wide factors and aggregate consumption patterns of consumers. However, since investment and financing decisions of a company are not normally taken into consideration, asset pricing theories tend to have difficulties in explaining cross-sectional patterns in stock returns.

"Since the conventional capital pricing theory couldn't explain much of the observed return patterns, other branches in the field of study started booming, such as behavior finance, which explains patterns in stock and bond returns based on investors’ behavior biases. Our recent study, however, finds that determinants of stock returns are influenced by investment and financing decisions of a company to a large extent. Thus, we take a company’s capital structure into consideration in our latest series of research." Professor Yan explains, "Stock is not a representation of a pure asset, like a plant or equipments. In fact, it is leveraged due to debt a company takes on. After giving consideration to a company capital structure and corporate decisions, we found that our theoretical framework was able to make a series of prediction about stock returns that can be verified by data and provide an explanation for some observed "anomalies" that have troubled many finance scholars." Professor Yan's research on the relationship between financial leverage of a company and its stock returns has been widely cited by other researchers. He believes that it is one area of research that still shows promise of yielding more insights about stock return patterns.

In recent years, the stock market in China remains in the doldrums. Investors can hardly accept the fact of a lost decade for the Chinese stock market, which doesn’t seem to match with China’s fast-growing economy over this period. “An important issue of the Chinese stock market is its lax disclosure requirement and lack of enforcement of rules.” Professor Yan points out, “the order of markets is reflected in proper information disclosure, which reduces information asymmetry that is hurting small investors and largely responsible for manipulations in the market. However, small investors hold a large proportion of the market. It is information asymmetry itself that results in irregular acts in the market, and distorts the operation of and pricing in the entire market. Moreover, there are problems with the equity structure of China’s listed companies and regulatory disclosure policies; hence, corporate governance of listed companies in China can still be improved upon massively.”

Guo Shuqing, chairman of the China Securities Regulatory Commission, completed a year on the job on Oct. 29, 2012. His performance over the past year can be best encapsulated in one word — reforms. Since taking over the securities regulator, he has introduced 70 new measures, at an average rate of one reform measure in less than six days, aiming at improving the investment climate and promoting the healthy development of the securities market.

Shareholders should in principle have the right to determine operational decisions of a publicly-held company. Consequently, the Board should be responsive to the interests of shareholders. However, in fact, companies in China don’t represent and protect the interests of small investors. Without investment value in this case, the stock market become a speculative one for those who make quick trades. This usually results in price distortions and chaotic investment order in the market. Under these circumstances, even if there are positive policies, they may not produce desirable effects. The market order and shareholder interests are twp of the fundamental problems of China’s stock market. “As long as these fundamental problems continue without a solution, any new reform measures may just be palliative. They wouldn’t be sufficiently effective. Investors who have been fooled a couple of times would lose their confidence in the market, and stay away from it. If markets are there only for speculative trading without investment value, there will be chaos in these markets,” says Professor Yan.

Developing SAIF as an international destination for China-related Financial Research

Devoting most of his time on academic research, teaching, and administrative work every single day, Professor Yan hardly has any spare time for his hobbies. “I like travelling and sports, but there is little time to do such things now,” he says, “there is a lot of SAIF’s work to do. On the other hand, I hope to find more time for reading, not only academic books, but also those books that can really deepen my understanding of our society, history and humanity.”

Looking to the future, Professor Yan says, in addition to on-going research projects, he intends to focus more of his effort on Chinese financial markets, such as further development of the Chinese fixed income market as well as the stock market. He suggests that treasury futures, financial commodity futures and options, as well as stock options will have a great impact on Chinese financial markets as well as providing tools for corporations to better manage their risk exposures. Therefore, in this regard CAFR could help financial institutions make good use of these new derivatives, and help enterprises achieve better risk management

When it comes to the future development of SAIF, Professor Yan believes that SAIF has made great progress in the past few years, in terms of both programs and research. “It is crucial for us to seize the next few years. We are at the period of development after the explosive growth in the early period. Things range from operational and research infrastructures to cultivation of top-flight professors and staff need to be brought to a higher level.”

As an associate director at China Academy of Financial Research, Professor Yan points out that high-quality research output is the hallmark of a world-class institution of higher learning. In the realm of research, there is still a lot of work to do, especially on China’s markets and financial institutions. “Since we have a foothold in China, our advantage and objective is to develop SAIF and CAFR as an international top place, a destination, to come for China-related financial research. In the future, once people discuss China’s financial issues, SAIF should be the first thought that comes to mind,” he says and hopes for SAIF’s future.