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A Bayesian Game For A Profit And Loss Sharing Contract

Author

Listed:
  • Djaffar Lessy

    (Université Côte d’Azur, IAIN Ambon, France and Indonesia)

  • Marc Diener

    (Université Côte d’Azur, France)

  • Francine Diener

    (Université Côte d’Azur, France)

Abstract

This paper presents a Bayesian game model for a profit-and-loss sharing (PLS) contract. We develop the model in two parts, one for a non-social bank and the other for a social bank. The model is proposed to reduce the adverse selection problem inherent in PLS contracts. The game starts with incomplete information; Islamic banks do not know exactly what type of agent is applying for a PLS contract, and whether the agents are efficient or non-efficient. We assume that the banks assign the agent type to a prior probability. Determination of the profit-sharing ratio of the contract is then discussed, and we look for the Bayesian Nash equilibrium as a solution or outcome of the game.We show that banks offer interesting but risky contracts to agents if they assign high probability to the agents being efficient. In contrast, they offer less risky contracts if they assign high probability to the agents being non-efficient. The results can be considered by Islamic banks to reduce the adverse selection problem in PLS contracts.

Suggested Citation

  • Djaffar Lessy & Marc Diener & Francine Diener, 2021. "A Bayesian Game For A Profit And Loss Sharing Contract," Journal of Islamic Monetary Economics and Finance, Bank Indonesia, vol. 7(3), pages 431-456, August.
    • Handle: RePEc:idn:jimfjn:v:7:y:2021:i:3a:p:431-456
    DOI: https://doi.org/10.21098/jimf.v7i3.1367
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    More about this item

    Keywords

    Bayesian game; Profit and loss sharing; Adverse selection; Islamic finance;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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