Contingent Claims Analysis and Life Cycle Finance
Boston University - Department of Finance & Economics
Ziff Brothers Investments - Risk Management
Board of Governors of the Federal Reserve System
January 19, 2012
American Economic Review, Forthcoming
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, job-switching, life-cycle, Arrow-Debreu securities
JEL Classification: D11, G11, J24
Date posted: January 21, 2008 ; Last revised: March 27, 2012
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