Combining finance and mathematics - an interview with Can Gao

Sitting in front of two massive computer screens in his office on Unterer Graben, Assistant Professor Can Gao takes a break from building his own server to service all of the data he hopes to analyse for his research to talk to us. We sat down with him to learn more about what brought him to HSG, his background and his research topics.

How did you end up in St.Gallen? Where have you studied, where have you worked, do you have roots in Switzerland?

Half of my family is Swiss and I wanted to relocate back to Switzerland. The opportunity in St.Gallen was, for me, the right place at the right time.

I started my first Ph.D. in Mathematics at Ecole Polytechnique Federale de Lausanne. Switzerland was the first country I lived in after leaving China at age of 22. Incidentally, I won a prize in a stamp design competition when I was nine in Yangzhou (my hometown), and the award ceremony was hosted alongside the joint issue of a set of stamps that celebrates the friendship between Lac Leman in Lausanne and the Slender West Lake in Yangzhou. So I guess I was always destined to come to Switzerland.

After my Mathematics Ph.D., I moved to London and worked a few years in the financial industry as quantitative researcher for various companies. During that same period, I completed my second Ph.D., this time in Finance at Imperial College London. 

With both a Ph.D. in Mathematics and in Finance, how has your background set you apart from your colleagues or how does it influence the way you approach research topics?

I guess it certainly makes it easier for me to digest all those technical papers in Finance. :)

The scientific training I received in both fields has made me more sensitive to the technical assumptions and frameworks that other researchers use. I usually am hard on myself when coming up with a conceptual framework for my studies, for example. It often leads to insights that are interesting or new to others. As we usually say, the devil is in the details. Attention to these maths-influenced ideas has helped me develop unique research ideas.

You have recently done some work on stock market valuation and detecting bubbles. What was your study and what were your findings?

The Study was called Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment. Along with Prof. Ian Martin from the London School of Economics, we looked at how market prices can tell us about levels of optimism. The question we asked was how confident or optimistic does an investor have to be to believe that the stock market is fairly valued. If the answer to that question is that you would have to be extremely positive, then that could indicate there is a bubble in the current market or it is over-valued.

Valuation ratios (share value compared to another metric like profit) are often used as way to determine if investor sentiment is high or low, but we felt this did not capture the full picture. Valuation ratios can be high, as they have been for a while now, for good reason. For example, they could be high primarily because interest rates have been low, and (or) volatility has been low. Our study assesses whether valuation ratios are too high or too low given the current volatility rates and interest rates.

The paper has been well received. It is published in one of the top journals in Finance. We presented it at several central banks around the world, including the Bank of England, the Federal Reserve New York, and the European Central Bank. Bank of England’s research staff also replicated our work using the UK market data. We are looking into if there is a need to regularly update our work and give real-time updates of investor sentiment indicator of stock market index.

What are you working on currently?

I recently posted a working paper titled Debt and Deficits: Fiscal Analysis with Stationary Ratios. It is a joint work with scholars from Harvard and LSE. We study the relationships among fiscal variables and output and use them to introduce a new measure of the government’s fiscal position. We find that a deterioration in the fiscal position forecasts a decline in government spending over the long run. It does not forecast increases in tax revenue; nor does it forecast low returns for bondholders. Fiscal adjustment to tax and expenditure shocks occurs primarily through mean-reversion in tax and expenditure growth, with a negligible contribution from expected and unexpected debt returns.

Do you know what your next project is?

There are several in the pipeline. I will study intraday behaviours of option markets to investigate how financial market convert new information into prices. Another direction would be to revisit the valuation framework of individual firms and investigate how the market reacts to the firm’s future reinvestment or pay-out policies.