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Contract as Automaton: The Computational Representation of Financial Agreements

Author

Listed:
  • Mark D. Flood

    (Office of Financial Research)

  • Oliver R. Goodenough

    (Office of Financial Research)

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 (also known as a finite-state automaton). 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 event arrivals 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.

Suggested Citation

  • Mark D. Flood & Oliver R. Goodenough, 2015. "Contract as Automaton: The Computational Representation of Financial Agreements," Working Papers 15-04, Office of Financial Research, US Department of the Treasury, revised 27 Mar 2017.
    • Handle: RePEc:ofr:wpaper:15-04
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    References listed on IDEAS

    as
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    Cited by:

    1. Vinay K Chaudhri, 2022. "Computable Contracts in the Financial Services Industry," Papers 2208.04685, arXiv.org.

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