Contract as Automaton: The Computational Representation of Financial Agreements

50 Pages Posted: 22 Aug 2015 Last revised: 15 Sep 2020

See all articles by Mark D. Flood

Mark D. Flood

R. H. Smith School of Business, U. of Maryland

Oliver R. Goodenough

Vermont Law School

Date Written: March 27, 2017

Abstract

We show that the fundamental legal structure of a well-written financial contract follows a state-transition logic that can be formalized mathematically as a finite-state machine (specifically, a deterministic finite automaton or DFA). The automaton defines the states that a financial relationship can be in, such as "default," "delinquency," "performing," etc., and it defines an "alphabet" of events that can trigger state transitions, such as "payment arrives," "due date passes," etc. The core of a contract describes the rules by which different sequences of events trigger particular sequences of state transitions in the relationship between the counterparties. By conceptualizing and representing the legal structure of a contract in this way, we expose it to a range of powerful tools and results from the theory of computation. These allow, for example, automated reasoning to determine whether a contract is internally coherent and whether it is complete relative to a particular event alphabet. We illustrate the process by representing a simple loan agreement as an automaton.

Keywords: Financial contracting, state-transition system, deterministic finite automaton, theory of computation, contractual complexity

JEL Classification: D86, K12, C63

Suggested Citation

Flood, Mark D. and Goodenough, Oliver R., Contract as Automaton: The Computational Representation of Financial Agreements (March 27, 2017). Office of Financial Research Working Paper No. 15-04, Available at SSRN: https://ssrn.com/abstract=2648460 or http://dx.doi.org/10.2139/ssrn.2648460

Mark D. Flood (Contact Author)

R. H. Smith School of Business, U. of Maryland ( email )

College Park
College Park, MD 20742
United States

Oliver R. Goodenough

Vermont Law School ( email )

164 Chelsea Street
P.O. Box 96
South Royalton, VT 05068
United States
802 831 1231 (Phone)

HOME PAGE: http://www.vermontlaw.edu/Our_Faculty/Faculty_Directory/Oliver_R_Goodenough.htm

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