An Economic Explication of the Prohibition of Gh ̄ arar in Classical Islamic Jurisprudence

The forbidden bay‘u al-gh ̄ arar can best be translated as “trading in risk”. In the face of risk, any trade would involve some degree of trading in risk, and thus jurists disagree over whether a specific contract is forbidden or not based on their varying assessments of whether the amount of risk is substantial or small. Moreover, the prohibition is often overruled in cases where clear economic benefit can only be served by a contract which includes substantial trading in risk. We show that “trading in risk” is generally inefficient relative to other forms of risk sharing. Hence if a contract can attain its economic aim of increasing economic efficiency through either form of risk transfer, the prohibition of trading in risk should be applicable. Cases where such a prohibition is moot because the risk trading instrument is not used do not affect this general conclusion. In cases where trading in risk is integral to the contract, but where the contract is important to meet economic needs (e.g. salam and ’istis .nā‘), the analysis is still useful in two regards: (i) we can consider whether or not there is a risk sharing mechanism which can reduce part of the inherent trading in risk (e.g. financial vs. mutual insurance), and (ii) we should consider such alternatives if secondary tools for managing the resulting risk are sought. ∗This paper is prepared for the 4th International Conference on Islamic Economics to be held in Leicester, UK, 13-15 August 2000. The author is Chaired Professor of Islamic Economics, Finance, and Management, and Professor of Economics and Statistics, Rice University, MS-22, 6100 Main Street, Houston, TX 77005. [email protected], http://www.ruf.rice.edu/∼elgamal