The Pay‐for‐Success Contract: A Valuation Note

• Published in: The journal of futures markets Vol. 44; no. 9; pp. 1465 - 1473
• Main Authors: Andrikopoulos, Andreas, Tsekrekos, Andrianos E.
• Format: Journal Article
• Language: English
• Published: Hoboken Wiley Periodicals Inc 01-09-2024
• Subjects: Capital markets; Contracts; Innovations; Juvenile justice; option pricing; pay‐for‐performance contracts; pay‐for‐success contracts; social finance; social impact bonds; Social policy; Valuation
• ISSN: 0270-7314; 1096-9934
• DOI: 10.1002/fut.22534

ABSTRACT
Pay‐for‐success contracts are social and financial innovations in social policy and capital markets, respectively. This paper argues that they exhibit option‐like payoffs and implements standard option‐pricing arguments in assessing the value of investing in pay‐for‐success contracts. Sensitivities vis‐à‐vis contract specifications are reflected in the valuation formula and help reach investment and social policy decisions. These sensitivities are demonstrated via a numerical application that uses parameters drawn from the Massachusetts Juvenile Justice Pay for Success Initiative, the largest pay‐for‐success initiative in the United States at the time of its launch.