Contingent Claims Analysis and Life Cycle Finance

12 Pages Posted: 21 Jan 2008 Last revised: 27 Mar 2012

Zvi Bodie

Boston University - Department of Finance & Economics

Jonathan Treussard

Ziff Brothers Investments - Risk Management

Doriana Ruffino

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: January 19, 2012

Abstract

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.

Keywords: Contingent claims, job-switching, life-cycle, Arrow-Debreu securities

JEL Classification: D11, G11, J24

Suggested Citation

Bodie, Zvi and Treussard, Jonathan and Ruffino, Doriana, Contingent Claims Analysis and Life Cycle Finance (January 19, 2012). American Economic Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1085563

Zvi Bodie (Contact Author)

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Jonathan Treussard

Ziff Brothers Investments - Risk Management ( email )

New York, NY
United States

Doriana Ruffino

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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