René Garcia

Professor of Finance at EDHEC Business School and Director, EDHEC PhD in Finance, teaches Empirical Methods in Finance core course

What is your research focus?

Mainly, I work in empirical asset pricing and econometrics. In empirical finance, my focus is normally to test asset pricing theories and models rather to than produce stylised facts from observation or present empirical puzzles. In econometrics, I have been concentrating on Markov-switching models ever since I became a researcher. These models involve multiple equations that describe the behaviour of time series in different regimes, brought by cycles or crises for example, and they can switch between these regimes to capture complex dynamic patterns over time – inevitably, they are also known as regime-switching models. As a doctoral student and then throughout my career, I have explored the applications of regime-switching models to asset pricing. For example, my co-authors and I have recently been working on a long-run risk model with volatility risk and disappointment aversion that explains the average and the volatility of the risk premium and the risk-free rate, the average of the variance premium and realised volatility, the predictability of returns by the dividend ratio, the long-run predictability of cumulative returns by the past cumulative variance, the short-run predictability of returns by the variance premium, and even daily autocorrelation patterns at many lags of the VIX and of the variance premium and cross-correlations of these two measures with leads and lags of daily returns. This model sheds new light on the risk-return trade-off at short and long horizons and extends earlier work of ours that appeared in The Review of Financial Studies in 2011.

I also have other research interests; in the not-sodistant past, I worked on the risk and performance of hedge funds in the context of a research chair established by Newedge at EDHEC-Risk Institute and I am currently working on a survey of recent advances in macro-finance applied to term-structure models, which is to be included in a handbook of macrofinance edited by University of Chicago Professor and affiliate faculty member Pietro Veronesi.

You presented work on funding liquidity and its implications for asset pricing at the American Finance Association meeting earlier this month, work that PhD in Finance participants and central bankers had the opportunity to preview last year; could you tell us more about it?

Theory predicts that frictions in the funding markets of financial intermediaries should transmit to the cross-section of securities. The intuition is that when funding liquidity constraints bind, intermediaries need to restructure their portfolios and sell securities that are expensive to hold. While a number of theoretical papers have been written on this topic, there was a shortage of empirical evidence due to a lack of reliable empirical measures of funding liquidity. Therefore, the practical effects of funding liquidity on security prices remained largely unexplored.

In previous work with Doctor Jean-Sébastien Fontaine, principal researcher in the financial market department of the Bank of Canada, we developed a measure of funding liquidity – which uses deviations from arbitrage in a panel of Treasury bond pairs with similar cash flows, but different ages – and showed that it was related to asset growth in the shadow banking sector and a predictor of risk premia across a wide range of fixed income markets; the paper appeared in The Review of Financial Studies in 2012.

The work presented at the last annual meeting of the American Finance Association was co-authored with Jean-Sébastien Fontaine and Doctor Sermin Gungor, also of the Bank of Canada. It is an empirical paper that focuses on measuring the impact of funding liquidity shocks on equity prices. The study finds that the cross-sectional dispersion of illiquidity, volatility, and returns widens when funding conditions deteriorate. We find that funding liquidity risk is priced and that the funding liquidity risk premium explains the crosssection of returns across liquidity-, volatility-, and size-sorted portfolios. This is strongly supportive of the prediction that funding liquidity plays a significant role in the determination of equity liquidity, volatility, and risk premium and of limits-to-arbitrage theories based on frictions in the intermediation mechanism.

You had recently joined EDHEC Business School when EDHEC-Risk Institute sounded you out about building a doctoral programme. What was your reaction to the idea of creating a PhD in Finance programme that would primarily target executives?

Initially I was sceptical; this was a new idea to me. While I had witnessed or helped people with doctoral qualifications in physics or mathematics make the switch to finance and then go on to work in the industry, I had never envisioned experienced finance professionals acquiring a PhD while remaining in the industry. But my colleagues heading EDHEC-Risk Institute and the research centre’s executive education arm convinced me there was a demand, so I set out to design a doctoral programme that would cater to this audience.

Precisely, how did you approach this challenge

I knew clearly I did not want to reproduce the Doctor of Business Administration approach whereby participants focus on applying theory to business problems or in any way water down PhD standards with the excuse that the class would be skewed towards executives. So the conundrum was to structure a doctoral programme in such a way that it would fit the schedule of experienced professionals while not only including a rigorous coverage of the subject matter but also requiring participants to produce original research that would advance knowledge in finance. The key involved a particular blend of format and contents. The combination of a block-week format with an e-learning platform that allows for on-demand delivery of multimedia recordings of class sessions made it possible for participants to join the programme without sacrificing their full-time jobs. Faced with a wide dispersion of international practices, striking the right balance between coursework and supervised research was also important. At one extreme, some doctoral education systems assume that participants need no coursework and should immediately start their dissertation work. At another extreme, there is the “participant as a blank slate” model that justifies a qualifying period of two years of (mostly) core courses followed by comprehensive examinations, the taking of electives and a transition towards dissertation work that may bring the scheduled programme duration to six years. Targeting an audience of exceptionally talented and hard-working individuals who would be equipped with advanced degrees in relevant fields and come to the class with a wealth of experience in finance, we assumed participants would have a solid background in economics and statistics and focused the first year of the programme on four advanced core courses and comprehensive examinations, and the second and third years on dissertation work supported by highly-specialised electives. Taking into account that the objective of the programme was primarily to train practitioners who, upon graduation, would remain in the industry to advance knowledge and practices rather than join academe, we set the research requirements of the degree to two papers that would be worthy of publication in scientific journals that target sophisticated professionals such as The Journal of Portfolio Management or Journal of Investment Management or Financial Analysts Journal. To enter a full-time academic career at a leading research university, you would normally be required to have authored three articles and to be on track for getting at least one of these published in an outlet with one of the field’s top impact factors – we do not discourage participants who want to follow this route, but we warn them of the longer time commitment that this represents. To bring participants to the required level in some three years of intensive, but part-time, work, the programme required to attract individuals of extraordinary calibre and motivation. This in turn demanded not only that we be smart in the design and formatting of a bona fide PhD, but also that we got some of finance’s leading minds to endorse and teach the course.

How did you select these experts and bring them on board?

To teach the core courses, I mainly turned to my colleagues in the permanent faculty who combined strong research credentials in each of the subjects with a track record of teaching or advising doctoral students at other institutions as well as experience of executive education or consulting.

To teach the electives, I aimed for the world’s specialists in a wide cross-section of specialised areas. Given the breadth and depth of expertise that we wanted to cover, this had to involve top scholars at multiple leading institutions. I approached the task by tapping into the networks of co-authors and contacts that I, and other senior permanent faculty members, had built along the years. I aimed for the best for the job and got excellent reception. As they dominate their fields and are used to a dialogue with the industry as advisors or instructors, these experts did not feel threatened by the idea of a PhD targeting practitioners, but instead thought there may be something to learn from the experience and they accepted to endorse the programme as we were still building it. So that is how we brought them on board and I am proud to say that they have remained aboard. As a matter of fact, programme faculty members have been impressed by the level of our students and have derived much enjoyment from the unique quality of interaction that is created when you assemble a group of participants who bring a wealth of professional experience to the classroom while being united by advanced training and a shared commitment to learning. Engaging such students is extremely rewarding and it is all the more exciting when this is done in the context of a module that allows you to survey the latest advances and current trends in your field of expertise as well as your ongoing work. This is a rare experience.

The programme is now in its sixth year of operation; what have been the main sources of satisfaction for you?

The proof of the pudding is in the eating, so the main source of satisfaction is that participants have been able to graduate, typically after three to four years of work as was targeted, and that they contribute to advancing knowledge and practices in the industry – while the latter is hard to take stock of, some graduates have created financial services or asset management companies to continue the research work done in the programme and monetise its applications, and other have put in the extra effort required to get their work published in practitioneroriented journals and occasionally in the most selective academic journals. Another source of contentment is the high level of satisfaction reported by programme participants be they students, core faculty or affiliate faculty.

You have advised a significant number of doctoral candidates to successful programme completion, at EDHEC Business School and before; how do you approach this exercise?

My philosophy is to give students a lot of latitude to find their way, both in terms of identifying their topics and in putting together their dissertations, but of course I have to adjust my supervisory style and amount of guidance for each student. Some will only need a few interventions at crossroad moments to find the right path, while others will require more intensive advising. What is key in both cases is for students to identify an area they really like, develop a thorough understanding of this area and find an original way to address a new topic. With a better knowledge of the literature, at least initially, and a better appreciation of what constitutes an original contribution, the advisor can play an important role in the process. Of course advising also has a psychological aspect to it and supporting students throughout the dissertation process is part of the job; this is a long, winding and bumpy road and there will be setbacks along the way – often, the data will be uncooperative, at times students will find themselves at dead ends and will need reorientation and encouragement.

Who do you think this programme is for?

The EDHEC-Risk Institute PhD in Finance is intended for people who, after a number of years in the industry, feel the need to think in a deeper and broader way about finance and what they have been doing.

The classic participant has always had a genuine thirst for knowledge and has always wanted to take it to the ultimate level. Typically, participants have demonstrated a high degree of commitment to professional development and learning in their field, by acquiring advanced degrees, professional qualifications and certificates and attending specialised executive courses. Doing the PhD takes them to a whole new level where they not only develop an integrated view of finance and acquire a depth of expertise in a variety of topics, but where they also learn to identify and research questions that contribute to advancing knowledge.

These professionals do not approach the PhD as a means to advancing their careers – many of them already are at the apex of their respective careers – but instead as an opportunity to quench their thirst for knowledge. While achieving a PhD will open many new opportunities for them, this is not what draws them to the programme. This is good since this is precisely the type of motivation that is required to overcome the difficulties associated with the pursuit of this demanding programme. While motivation is vital, there are also fundamental criteria that need to be met that are key for success in the programme: an adequate background and preparation on the one hand, and the ability to make a significant and sustainable time commitment on the other. The concentrated nature of the programme requires that participants hit the ground running – there will be very little time to play catch-up once you have started on this course. I also mentioned that it was customary for participants to have studied part-time over the course of their careers; this is indicative of superior time management skills and certainly the ability to balance the demands from family, a high-octane career, and a rigorous doctoral programme is central to bringing this endeavour to a successful end.

What is your research focus?

Mainly, I work in empirical asset pricing and econometrics. In empirical finance, my focus is normally to test asset pricing theories and models rather to than produce stylised facts from observation or present empirical puzzles. In econometrics, I have been concentrating on Markov-switching models ever since I became a researcher. These models involve multiple equations that describe the behaviour of time series in different regimes, brought by cycles or crises for example, and they can switch between these regimes to capture complex dynamic patterns over time – inevitably, they are also known as regime-switching models. As a doctoral student and then throughout my career, I have explored the applications of regime-switching models to asset pricing. For example, my co-authors and I have recently been working on a long-run risk model with volatility risk and disappointment aversion that explains the average and the volatility of the risk premium and the risk-free rate, the average of the variance premium and realised volatility, the predictability of returns by the dividend ratio, the long-run predictability of cumulative returns by the past cumulative variance, the short-run predictability of returns by the variance premium, and even daily autocorrelation patterns at many lags of the VIX and of the variance premium and cross-correlations of these two measures with leads and lags of daily returns. This model sheds new light on the risk-return trade-off at short and long horizons and extends earlier work of ours that appeared in The Review of Financial Studies in 2011.

I also have other research interests; in the not-sodistant past, I worked on the risk and performance of hedge funds in the context of a research chair established by Newedge at EDHEC-Risk Institute and I am currently working on a survey of recent advances in macro-finance applied to term-structure models, which is to be included in a handbook of macrofinance edited by University of Chicago Professor and affiliate faculty member Pietro Veronesi.

You presented work on funding liquidity and its implications for asset pricing at the American Finance Association meeting earlier this month, work that PhD in Finance participants and central bankers had the opportunity to preview last year; could you tell us more about it?

Theory predicts that frictions in the funding markets of financial intermediaries should transmit to the cross-section of securities. The intuition is that when funding liquidity constraints bind, intermediaries need to restructure their portfolios and sell securities that are expensive to hold. While a number of theoretical papers have been written on this topic, there was a shortage of empirical evidence due to a lack of reliable empirical measures of funding liquidity. Therefore, the practical effects of funding liquidity on security prices remained largely unexplored.

In previous work with Doctor Jean-Sébastien Fontaine, principal researcher in the financial market department of the Bank of Canada, we developed a measure of funding liquidity – which uses deviations from arbitrage in a panel of Treasury bond pairs with similar cash flows, but different ages – and showed that it was related to asset growth in the shadow banking sector and a predictor of risk premia across a wide range of fixed income markets; the paper appeared in The Review of Financial Studies in 2012.

The work presented at the last annual meeting of the American Finance Association was co-authored with Jean-Sébastien Fontaine and Doctor Sermin Gungor, also of the Bank of Canada. It is an empirical paper that focuses on measuring the impact of funding liquidity shocks on equity prices. The study finds that the cross-sectional dispersion of illiquidity, volatility, and returns widens when funding conditions deteriorate. We find that funding liquidity risk is priced and that the funding liquidity risk premium explains the crosssection of returns across liquidity-, volatility-, and size-sorted portfolios. This is strongly supportive of the prediction that funding liquidity plays a significant role in the determination of equity liquidity, volatility, and risk premium and of limits-to-arbitrage theories based on frictions in the intermediation mechanism.

You had recently joined EDHEC Business School when EDHEC-Risk Institute sounded you out about building a doctoral programme. What was your reaction to the idea of creating a PhD in Finance programme that would primarily target executives?

Initially I was sceptical; this was a new idea to me. While I had witnessed or helped people with doctoral qualifications in physics or mathematics make the switch to finance and then go on to work in the industry, I had never envisioned experienced finance professionals acquiring a PhD while remaining in the industry. But my colleagues heading EDHEC-Risk Institute and the research centre’s executive education arm convinced me there was a demand, so I set out to design a doctoral programme that would cater to this audience.

Precisely, how did you approach this challenge

I knew clearly I did not want to reproduce the Doctor of Business Administration approach whereby participants focus on applying theory to business problems or in any way water down PhD standards with the excuse that the class would be skewed towards executives. So the conundrum was to structure a doctoral programme in such a way that it would fit the schedule of experienced professionals while not only including a rigorous coverage of the subject matter but also requiring participants to produce original research that would advance knowledge in finance. The key involved a particular blend of format and contents. The combination of a block-week format with an e-learning platform that allows for on-demand delivery of multimedia recordings of class sessions made it possible for participants to join the programme without sacrificing their full-time jobs. Faced with a wide dispersion of international practices, striking the right balance between coursework and supervised research was also important. At one extreme, some doctoral education systems assume that participants need no coursework and should immediately start their dissertation work. At another extreme, there is the “participant as a blank slate” model that justifies a qualifying period of two years of (mostly) core courses followed by comprehensive examinations, the taking of electives and a transition towards dissertation work that may bring the scheduled programme duration to six years. Targeting an audience of exceptionally talented and hard-working individuals who would be equipped with advanced degrees in relevant fields and come to the class with a wealth of experience in finance, we assumed participants would have a solid background in economics and statistics and focused the first year of the programme on four advanced core courses and comprehensive examinations, and the second and third years on dissertation work supported by highly-specialised electives. Taking into account that the objective of the programme was primarily to train practitioners who, upon graduation, would remain in the industry to advance knowledge and practices rather than join academe, we set the research requirements of the degree to two papers that would be worthy of publication in scientific journals that target sophisticated professionals such as The Journal of Portfolio Management or Journal of Investment Management or Financial Analysts Journal. To enter a full-time academic career at a leading research university, you would normally be required to have authored three articles and to be on track for getting at least one of these published in an outlet with one of the field’s top impact factors – we do not discourage participants who want to follow this route, but we warn them of the longer time commitment that this represents. To bring participants to the required level in some three years of intensive, but part-time, work, the programme required to attract individuals of extraordinary calibre and motivation. This in turn demanded not only that we be smart in the design and formatting of a bona fide PhD, but also that we got some of finance’s leading minds to endorse and teach the course.

How did you select these experts and bring them on board?

To teach the core courses, I mainly turned to my colleagues in the permanent faculty who combined strong research credentials in each of the subjects with a track record of teaching or advising doctoral students at other institutions as well as experience of executive education or consulting.

To teach the electives, I aimed for the world’s specialists in a wide cross-section of specialised areas. Given the breadth and depth of expertise that we wanted to cover, this had to involve top scholars at multiple leading institutions. I approached the task by tapping into the networks of co-authors and contacts that I, and other senior permanent faculty members, had built along the years. I aimed for the best for the job and got excellent reception. As they dominate their fields and are used to a dialogue with the industry as advisors or instructors, these experts did not feel threatened by the idea of a PhD targeting practitioners, but instead thought there may be something to learn from the experience and they accepted to endorse the programme as we were still building it. So that is how we brought them on board and I am proud to say that they have remained aboard. As a matter of fact, programme faculty members have been impressed by the level of our students and have derived much enjoyment from the unique quality of interaction that is created when you assemble a group of participants who bring a wealth of professional experience to the classroom while being united by advanced training and a shared commitment to learning. Engaging such students is extremely rewarding and it is all the more exciting when this is done in the context of a module that allows you to survey the latest advances and current trends in your field of expertise as well as your ongoing work. This is a rare experience.

The programme is now in its sixth year of operation; what have been the main sources of satisfaction for you?

The proof of the pudding is in the eating, so the main source of satisfaction is that participants have been able to graduate, typically after three to four years of work as was targeted, and that they contribute to advancing knowledge and practices in the industry – while the latter is hard to take stock of, some graduates have created financial services or asset management companies to continue the research work done in the programme and monetise its applications, and other have put in the extra effort required to get their work published in practitioneroriented journals and occasionally in the most selective academic journals. Another source of contentment is the high level of satisfaction reported by programme participants be they students, core faculty or affiliate faculty.

You have advised a significant number of doctoral candidates to successful programme completion, at EDHEC Business School and before; how do you approach this exercise?

My philosophy is to give students a lot of latitude to find their way, both in terms of identifying their topics and in putting together their dissertations, but of course I have to adjust my supervisory style and amount of guidance for each student. Some will only need a few interventions at crossroad moments to find the right path, while others will require more intensive advising. What is key in both cases is for students to identify an area they really like, develop a thorough understanding of this area and find an original way to address a new topic. With a better knowledge of the literature, at least initially, and a better appreciation of what constitutes an original contribution, the advisor can play an important role in the process. Of course advising also has a psychological aspect to it and supporting students throughout the dissertation process is part of the job; this is a long, winding and bumpy road and there will be setbacks along the way – often, the data will be uncooperative, at times students will find themselves at dead ends and will need reorientation and encouragement.

Who do you think this programme is for?

The EDHEC-Risk Institute PhD in Finance is intended for people who, after a number of years in the industry, feel the need to think in a deeper and broader way about finance and what they have been doing.

The classic participant has always had a genuine thirst for knowledge and has always wanted to take it to the ultimate level. Typically, participants have demonstrated a high degree of commitment to professional development and learning in their field, by acquiring advanced degrees, professional qualifications and certificates and attending specialised executive courses. Doing the PhD takes them to a whole new level where they not only develop an integrated view of finance and acquire a depth of expertise in a variety of topics, but where they also learn to identify and research questions that contribute to advancing knowledge.

These professionals do not approach the PhD as a means to advancing their careers – many of them already are at the apex of their respective careers – but instead as an opportunity to quench their thirst for knowledge. While achieving a PhD will open many new opportunities for them, this is not what draws them to the programme. This is good since this is precisely the type of motivation that is required to overcome the difficulties associated with the pursuit of this demanding programme. While motivation is vital, there are also fundamental criteria that need to be met that are key for success in the programme: an adequate background and preparation on the one hand, and the ability to make a significant and sustainable time commitment on the other. The concentrated nature of the programme requires that participants hit the ground running – there will be very little time to play catch-up once you have started on this course. I also mentioned that it was customary for participants to have studied part-time over the course of their careers; this is indicative of superior time management skills and certainly the ability to balance the demands from family, a high-octane career, and a rigorous doctoral programme is central to bringing this endeavour to a successful end.