Single or Menu Contracting: An application of the Hersanyi Model to Mudaraba Financing

• Main Authors: Adil EL Fakir, Mohamed Tkiouat
• Format: Article
• Language: English
• Published: EconJournals 2016-03-01
• Series: International Journal of Economics and Financial Issues
• Subjects: mudaraba; self-selection mechanism; adverse selection index; frequency of due diligence; islamic venture capitalist; incomplete information
• Online Access: https://dergipark.org.tr/tr/pub/ijefi/issue/32008/353672?publisher=http-www-cag-edu-tr-ilhan-ozturk

In Islamic banking, the offering of a Mudaraba contract to a privately informed agent results in adverse selection. In incentive theory, a hypothesis is that the seller, in our case the Islamic bank, may offer different menu of contracts to separate non-efficient agents from the efficient ones. To test this hypothesis, we apply a game theory approach using an incomplete information model combined with an adverse selection index. From a rational point of view a bank would like to offer a higher type contract to an efficient agent to get higher rewards. Under an asymmetric case, however, we found evidence that in some cases offering a lower type contract can result in higher social value. Menu offering is found not to be the ultimate solution for agent’s types’ separation.