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Concept
Contingent claim
Summary
In finance, a contingent claim is a derivative whose future payoff depends on the value of another “underlying” asset, or more generally, that is dependent on the realization of some uncertain future event.
These are so named, since there is only a payoff under certain contingencies.
Any derivative instrument that is not a contingent claim is called a forward commitment.
The prototypical contingent claim is an option, 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.
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,
decomposing the value of a corporate into a set of options in his "Merton model" of credit risk.
In financial economics contingent claim analysis is widely used as a framework both for developing pricing models, and for extending the theory. Thus, from its origins in option pricing and the valuation of corporate liabilities, it has become a major approach to intertemporal equilibrium under uncertainty. Simon Babbs and Michael Selby (1992). Contingent Claims Analysis, in The New Paigrave Dictionary of Money and Finance, eds J Eatwell, M Milgate and P Newman, Macmillan (1992), pp 437-440
This framework is therefore “broader than ‘option pricing’ because it encompasses the full gamut of valuation approaches directed toward the pricing of contingent claims.” This would include "the full range of models designed to price government, corporate, and mortgage-backed securities... as well as options and futures on fixed income securities." David F. Babbel and Craig R. Merrill (1996). Valuation of Interest-Sensitive Financial Instruments (SOA Monograph M-FI96-1). Wiley.
The general approach here is to define risky outcomes relative to states of the world, and to then use claims to represent and value state outcomes.
Official source
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