Contingent claim

In finance, a contingent claim is a derivative whose future payoff depends on the value of another “underlying” asset,[1][2] or more generally, that is dependent on the realization of some uncertain future event.[3] These are so named, since there is only a payoff under certain contingencies.[4] Any derivative instrument that is not a contingent claim is called a forward commitment.[3]

The prototypical contingent claim is an option,[1] the right to buy or sell the underlying asset at a specified exercise price by a certain expiration date; whereas (vanilla) swaps, forwards, and futures are forward commitments, since these grant no such optionality.[3]

Contingent claims are applied under financial economics in developing models and theory, and in corporate finance as a valuation framework. This approach originates with Robert C. Merton, [5] decomposing the value of a corporate into a set of options in his "Merton model" of credit risk.

  1. ^ a b Dale F. Gray, Robert C. Merton and Zvi Bodie. (2007). Contingent Claims Approach to Measuring and Managing Sovereign Credit Risk. Journal of Investment Management, Vol. 5, No. 4, (2007), pp. 5–28
  2. ^ M. J. Brennan (1979). The Pricing of Contingent Claims in Discrete Time Models. The Journal of Finance. Vol. 34, No. 1 (Mar., 1979), pp. 53-68
  3. ^ a b c Sean Ross. What kinds of derivatives are types of contingent claims?. Investopedia
  4. ^ "Approaches to valuation", Ch2. in Aswath Damodaran (2012). Investment Valuation: Tools and Techniques for Determining the Value of any Asset. John Wiley & Sons. ISBN 9781118206591
  5. ^ Zvi Bodie (2020). Robert C. Merton and the Science of Finance. Annual Review of Financial Economics, Vol. 12, pp. 19-38, 2020