The Pay-for-Success Contract: A Valuation Note

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.