World of WealthCraft: Using a virtual hand to nurture Islamic finance growth

1 thought on “World of WealthCraft: Using a virtual hand to nurture Islamic finance growth”

1. 

   Imran

   March 16, 2010 at 2:34 pm

   Assalamaleikum Wa Rahmatulah

   Well we can look at a few things in this case:

   Rational Pricing – http://en.wikipedia.org/wiki/Rational_pricing – which in the hybrid or dual state means (assuming no regulatory impediments) that the pricing for islamic and conventional products which are ‘equivalent’ in terms of risk and cashflow will be equally priced.

   The other thing to lack at here is the idea of complete and incomplete markets – http://en.wikipedia.org/wiki/Complete_market
   where you can manufacture a financial contract using existing products in the market – this idea is often used for say futures pricing where you would buy the spot product and then use the cost of capital and carry to work out the risk-free future price.

   To see how this is relevant – if the market is incomplete and there are not sufficient financial products (i.e. no interest based loans in an islamic economy) to allow the market to be complete – or it becomes expensive to synthesize them (i.e. using commodity murabah or tawarruq) making arbitrage difficult to occur (which is required for rational pricing.)

   This impacts the use of rational pricing and would explain why the ‘shariah’ spread of similar conventional/islamic products can be very small if arbitrage can occur by actors not tied by shariah constraints i.e. non-muslim financial players – but can be significantly different if the market is incomplete or the use of regulation prevents arbitrage from occuring.

   The other research worth looking at would be the electricity futures market – electricity unlike other commodity futures is expensive to store and transport – so the pricing for futures is different for electricity and there is research into this and how it differs to the other futures because the standard requirements for futures/spot arbitrage (aka basis trading) do not apply (due to storage and transport issues.)
   That may provide insight into what happens to the pricing of a market when fundamental assumptions (i.e. existence of interest rates and ability to acquire collateralise credit) do not apply and how the market deals with it.

   The interesting thing is how rational pricing theory plays wrt the arguements against using libor as a benchmark to price shariah compliant sukuks with – as using no arbitrage and rational pricing arguments – the obvious benchmark to use would be libor!

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