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Investigation of Profit-Loss Sharing and Fixed-Return Contracts Recovery Rate Using Game Theory Approach

Author

Listed:
  • Ashrafzadeh, Shokoofeh Sadat

    () (Ph.D. Candidates in Economics, Ferdowsi University of Mashhad International Campus)

  • Razmi, Seyyed Mohammad Javad

    () (Associate Professor of Economics, Ferdowsi University of Mashhad)

  • Lotfalipour, Mohammad Reza

    () (Professor of Economics, Ferdowsi University of Mashhad)

  • Feizi, Mehdi

    () (Assistant professor of Economics, Ferdowsi University of Mashhad)

Abstract

In loan contracts with profit-loss sharing (PLS), both sides share not only its expected profit but they both have to bear its probable losses as well. But in fixed interest-based loan contracts, the bank is simply risk natural and transfer all contract risks to borrower. Although in Islamic Sharia only the former contracts are accepted, it is not used that much in practice. In words, common loan contracts even in Islamic countries do not comply with the Sharia. This paper, using a game theory model, attempts to compare profit of banks these two sort of contracts based on recovery rate of borrowers when we have not only adverse selection but also costly state verification. We show that Sharia-compliant contracts (e.g. PLS) have significantly higher recovery rate compared to fixed interest-based contracts.

Suggested Citation

  • Ashrafzadeh, Shokoofeh Sadat & Razmi, Seyyed Mohammad Javad & Lotfalipour, Mohammad Reza & Feizi, Mehdi, 2017. "Investigation of Profit-Loss Sharing and Fixed-Return Contracts Recovery Rate Using Game Theory Approach," Quarterly Journal of Applied Theories of Economics, Faculty of Economics, Management and Business, University of Tabriz, vol. 3(4), pages 1-20, February.
  • Handle: RePEc:ris:qjatoe:0056
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    More about this item

    Keywords

    Profit-loss sharing; Islamic banking; Asymmetric and private information; Game theory; Interest-based contracts;

    JEL classification:

    • C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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