An Economic Explication of the Prohibition of Gharar in Classical Islamic Jurisprudence

The forbidden bay al-gharar can best be translated as “trading in risk”. Any trade would involve some degree of trading in risk. 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 can be waived in cases where clear economic benefit can only be served by a contract that 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 increase economic efficiency through some 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 inherent in the contract, but where the contract is important to meet economic needs (e.g. salam), 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, and (ii) we should consider such alternatives if secondary tools for managing the resulting risk are sought.