Financial contracts in interest-free Islamic economics: theory and practice (Ph.D. Dissertation)

This thesis, in three essays, discusses the absence of interest in Islamic financial transactions as the central feature of Islamic economics. Profit and loss sharing arrangements where risk is shared between lender and borrower replace traditional Western financial methods of lending. Moral hazard problems were believed to eventually cause a decline in the savings and investment rate. The author uses incentive theory in the first essay to formulate profit and loss sharing contracts between investors and for both moral hazard and adverse selection. The writer goes into the specifics of entrepreneurs having private information about their types. Contracts can be designed to induce them to reveal their private information truthfully. The efficiency of PLS contracts was investigated by the author by comparing them to standard debt contracts. The author asks the question: What contract maximizes the social welfare function subject to the rationality constraints? He notes that the P