Towards an Objective Measure of Gharar in Exchange

Written By Dinda Revolusi on Rabu, 06 April 2011 | 18.15

Although the legal aspects of gharar are well established in Islamic jurisprudence, researchers in Islamic finance constantly face the dilemma of defining the concept and its precise meaning. For example, Zaki Badawi (1998, p. 16) writes: “The precise meaning of Gharar is itself uncertain. The literature does not give us an agreed definition and scholars rely more on enumerating individual instances of Gharar as substitute for a precise definition of the term.” Frank Vogel (1998, p. 64) expresses a similar tone: “As with riba, fiqh scholars have been unable to define the exact scope of gharar.” These claims might well be exaggerating, but they point to the need for further contemporary formulation of the subject.

This paper is an attempt to develop an objective criterion to identify and measure gharar in exchange. It is shown that a gharar transaction is equivalent to a zero-sum game with uncertain payoffs. The measure helps economists view gharar within an integrated theory of exchange under uncertainty, so that it can be easily communicated to non-Muslim economists. Further, it provides a quantitative measure of gharar that can potentially be applied to innovative risky transactions. A Shari’ah-based measure is also developed, and the two criteria are shown to coincide and integrate each other.

The Islamic principle behind most illegal contracts is eating others’ money for nothing. A zero-sum exchange reflects precisely this concept: It is an exchange in which one party gains by taking away from the other party’s payoff, leading to a win-lose outcome. However, a rational agent will not accept to engage into a certainly losing game; only if loss is uncertain and gain is probable, that such game is played. Hence uncertainty or risk is what tempts rational agents to engage into an exchange which they know in advance that only one will gain from it while the other must lose. This temptation is best described by the term gharar, which means deception and delusion. It follows that a gharar contract is characterized as a zero-sum game with uncertain payoffs. This paper argues that such measure well
defines gharar transactions.

The paper also develops a Shari’ah based measure derived from the hadith: Liability justifies return or utility. It is shown the these two measures coincide and integrate each other. A quantitative formula is developed to examine gharar in nonzero-sum games, which helps formalizing conditions of unacceptable risk or excessive gharar mentioned by fiqh scholars. An examination of well known gharar contracts shows how the zero-sum measure is satisfied. The measure helps explaining why fuqaha take different positions on controversial nonzero-sum contracts, while unanimously prohibit strictly zero-sum contracts. Extending the measure to modern applications generates interesting results on how a certain contract, like the option contract, might or might not be gharar, depending on the structure of payoffs for the two players.

The economic significance of the zero-sum measure provides insights into the Islamic view of economic behavior. Elimination of zero-sum arrangements can be viewed as a paradigm governing Islamic principles of exchange. Not only this paradigm is internally consistent, it is also consistent with rationality as defined by Neoclassical economics. Consequently, modern analytical tools are readily available for Muslim economists without compromising Islamic principles There is much to be studied and analyzed, and I hope that this paper presents a proper starting point for building a coherent theory of exchange in Islamic economics.

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