Contingent Claims Analysis and Life-Cycle Finance
Boston University - Department of Finance & Economics
University of Minnesota
Ziff Brothers Investments - Risk Management
March 24, 2008
MIT Sloan Research Paper No. 4676-08
This paper explores the application of contingent claims analysis (CCA) to two "hot" issues in life-cycle finance: (1) investing for retirement and (2) deciding when, if ever, to switch careers. Participants in individual retirement accounts do not have the time or the knowledge to make their own investment decisions. Today they are defaulted into life-cycle mutual funds that pass all risk directly through to the participant. We use CCA to demonstrate how financial firms can design and produce guaranteed contingent benefit contracts that improve participant welfare at no additional cost to the system. In exploring the career-choice issue in the second part of the paper, we use CCA in a somewhat different way. The decision to switch careers is analogous to deciding when to exercise an American-style option to swap one asset for another. By applying the methods used to analyze the option-exercise decision to the career-switching problem, we gain some new insights beyond those derived from the traditional dynamic programming approaches.
Number of Pages in PDF File: 12
Keywords: contingent claims analysis, life-cycle finance, retirement saving plans
JEL Classification: G11, G13, G22, G23, C61, D11, D81, D91working papers series
Date posted: December 27, 2007 ; Last revised: November 16, 2008
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