Toward an Islamic Finance Theory

In typical settings of consumption, productive opportunities, and capital markets, we model the behavior of a Muslim agent who exhibits neoclassical preferences, absolute risk aversion, and a binding faith constraint called Sharia. In the certainty model, the agent requires a real return that reduces to the standard, nominal return in the neoclassical model. In the uncertainty model, however, the agent requires a real return that deviates sharply from the neoclassical counterpart. That deviation reiterates the Muslim time value of return (TVR) as opposed to the neoclassical time value of money (TVM). Toward this end, the major thesis of Islamic finance is that money can't earn standalone economic rent, but can be rather rewarded when used in conjunction with other factors to generate value added from production or utility flow from consumption