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Posted 4.18.12

Weatherhead Finance PhD, Coauthors Win $25K from S & P

Rong Fan, PhD ’02, and coauthors won a prestigious award for a paper that explores the origin of liquidity shocks like those that harmed financial institutions in the recent economic crisis. Their paper, “An Index-Based Measure of Liquidity,” placed second in the first annual SPIVA Research Award competition sponsored by the S & P Indices. Peter Ritchken, PhD, Kenneth Walter Haber Professor of Banking and Finance, was Dr. Fan’s doctoral advisor at Weatherhead and recalls that her dissertation on interest rate risk helped her land a position at Gifford Fong Associates in San Francisco. After spending time there and at several investment banks in New York and Los Angeles, Fan returned to GF in her current role as Director of Research.

For their submission to S & P’s competition, Fan and her colleagues investigated problems in the pricing of securities due to the difficulty of measuring liquidity risks. They asked what would happen if shares of an exchange-traded fund (ETF)--a diversified portfolio of stocks--were sold at a value greater than the sum of their parts.

“It’s like a Happy Meal,” explains Dr. Ritchken. “The price of the Happy Meal can never be greater than the value of the burger, fries and soft drink. In fact, the price should be less than their total value. Otherwise, it’s not a bargain, and no one would buy it.”

But sometimes, the value of an ETF does deviate from its net asset value (NAV), and Fan’s team used these value mismatches to derive information about the level of liquidity risk associated with shares of an ETF versus shares of its individual assets. Because the two products are essentially the same (except that one is more liquid than the other), the discrepancy between their prices clearly reveals the liquidity risk. This approach to measuring liquidity was deemed “innovative” by judges.

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