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Faculty Profile: Distinguished Professor of Finance Andrew Chen
By Jennifer Warren
While a graduate student at U.C. Berkeley in September 1967, Cox Distinguished Professor of Finance Andrew Chen was first published in the Journal of Financial and Quantitative Analysis. Nearly four decades ago, his dissertation focused on options pricing at a time when options were not even in the mindset of financial professionals. Since that time, Chen has become one of the most prolific authors over the 50-year period 1953 - 2002 based on the number of articles published in 72 finance journals—ranking #11 in the world. If the work he produced under his original Chinese name of Houng-Yhi Chen had also been considered, he may have ranked even higher. In the seven leading finance journals during the same 50-year period, he ranks #47 of the 332 most prolific authors. Over the years, Chen has demonstrated a broad intellectual curiosity across a wide range of topics in finance and economics.
Accounting for Uncertain Inflation
In 1975, a time of double-digit inflation, Chen determined that the most widely taught and used formula for analyzing returns on investment, the capital asset pricing model (CAPM), failed to account for uncertain inflation. His model in the paper “Effects of Uncertain Inflation on the Investment and Financing Decisions of a Firm” included inflation risk in the equation and thus more accurately measured returns to investment. This proved consequential to firms that perform well in inflationary times and those that do not.
A Novel Approach to Pension Funding and Investing
Ten years later, Chen formulated a new approach to pension funding and investing that lay between two opposite assessments espoused by leading academics of the time: Nobel Prize winner William Sharpe and Fischer Black. Sharpe advocated that corporations should contribute the minimum amount toward employee pension funds with the maximum of the funds placed in stocks, a higher risk proposition since the Pension Benefit Guaranty Corporation (PBGC) would pick up the tab in case of default. Black’s argument considered the tax consequences of pension investing and emphasized making the maximum of contributions in taxable corporate bonds and a minimum in stocks. Chen concluded that their two divergent approaches did not properly consider the effects of both taxes and insurance. Believing that the answer lay in the middle ground, Chen posited that considering both taxes and insurance effects would offer a more stable approach to pension funding and investing.
Effects of Terrorism on Capital Markets
Oftentimes Chen’s inspiration for a research topic arises from events of the day. The terrorist attacks of September 11, 2001, proved one such time. He and co-author Thomas Siems of the Dallas Federal Reserve Bank wrote about the effects of 9/11 and other terrorist and military events on global capital markets in “The Effects of Terrorism on Global Capital Markets,” published in the European Journal of Political Economy, June 2004. In this paper, they illustrated the capabilities and resilience of U.S. capital markets and the Fed’s response to highlight a milestone in economic history. In the days that followed 9/11, the U.S. Federal Reserve Bank provided massive liquidity to the banking and financial system, virtually at the click of a mouse. The confidence of U.S. financial markets was quickly restored. In fact, U.S. capital markets recovered faster than other large international capital markets, including those in London, Tokyo, Frankfurt, Paris, Amsterdam, Switzerland, Italy, and Hong Kong.
When asked of his future plans, Chen remarked that he will continue identifying and solving the puzzles that contemporary finance and economics brings, and share this newfound knowledge with colleagues and students.
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